What is a Balance Sheet, Its Components & Significance

What Does the Term Balance Sheet Signify?

A balance sheet offers a snapshot of a company's financial status at a given moment. It outlines assets, liabilities, and shareholders' investments, serving as a crucial financial statement.

The balance sheet complies with the following accounting equation:

Formula: - Assets = Liabilities + Shareholders’ Equity

This implies that the company's assets, and its owned resources, must equate to the sum of its liabilities—debts, and obligations—and shareholders' equity, which embodies their investments.

To maintain this equilibrium, companies use double-entry bookkeeping. Each acquisition or transaction affecting an asset, liability, or equity item (debit or credit) corresponds with an impact on another account in the balance sheet but in the opposite manner (debit or credit).

Main Components of Balance Sheet

The balance sheet consists of 3 major elements-

Assets
Liabilities
Shareholders’ equity

Each element comprises distinct accounts. Below we furnish the additional information.

1. Assets

Assets encapsulate the valuable possessions owned by a company. These are detailed on a balance sheet, arranged by their liquidity—their ability to be swiftly converted into cash. They are categorized into current assets and non current (long-term) assets based on their nature.

Current assets are those expected to be converted to cash within one year.

Common Current Asset Accounts Cover

Receive Account: The outstanding balances that customers owe to the company for goods or services received on credit.
Catalogue: Materials, work-in-progress items, and finished goods possessed by the company that will ultimately be sold.
Cash and Equal: This includes physical currency as well as easily convertible assets like money market funds and short-term bonds.
Marketplace Equity Securities: These are highly liquid investments that can be easily converted into cash, in this bonds and publicly traded equity securities are included.
Prepaid Cost: Advance payments carried out by the company for future services like insurance or rent.

More than one year is required for Non-current assets to be converted into cash and they cover:

Plant, Property, and Equipment (PP&E):Tangible fixed assets like land, buildings, and equipment used by the company in its daily operations.
Non-physical Assets:In this Non-physical assets are included such as patents, trademarks, copyrights, and goodwill.
Long-term Financial Investments: Financial assets anticipated to be converted into cash in a period longer than a year.

2. Liabilities

Liabilities depict the financial responsibilities that a company owes to external parties and can be classified into current and non-current liabilities depending on when they are due for payment for 1 year and more than 1 year, respectively.

Current Liability of Accounts Cover

Accrued Price: Expenses incurred but not yet paid, such as unpaid wages to employees.
Payable Income Taxes:Taxes owed but not yet paid.
Payable Accounts: Amounts owed to suppliers and short-term creditors.
Company Short-term Debt: The company’s debt obligations are due within one year, such as the current portion of bank loans.

Common Non-Current Liabilities Cover

Deferred Taxes: Taxes on earnings that have been due are postponed to future years.
Pension Responsibility: Long-term liabilities related to the company's pension plan.
Long-term Debt:Debt responsibilities remaining for more than one year including bonds and the portion of a loan's principal due more than one year from the present.

3. Shareholder’s Activity

Shareholders' equity signifies the capital invested by shareholders and the cumulative gains or losses. Key elements cover:

Keep Incomes: The aggregate net income earned over the years subtracting any dividends paid to shareholders.

Finance Stock:Shares repurchased from stockholders to reduce the number of float shares and increase the value per share.

Capital Paid-in: The money invested in the company through the purchase of shares.

Extra paid-in Capital: The amount invested by shareholders that is more than the purported value of the shares.

Preferred stock, if issued by the company, will be listed separately from the typical stock under this section.

An Example of a Balance Sheet

Company ABC Balance Sheet

As of December 31, 2023

(in thousands)

Assets

Inventory	$4,500
Accounts Receivable	$6,700
Cash and Equivalents	$1,500
Total Current Assets	$12,700
Property Plan and Equipment	$68,000
Total Assets	$80,700

Liabilities

Accounts Payable	$3,600
Total Current Liabilities	$4,400
Taxes Payable	$800
Long-Term Debt	$25,000
Total Liabilities	$29,400

Shareholder’s Equity

Paid-In Capital	$1,000
Retained Earnings	$29,000
Additional Paid-In Capital	$21,300
Shareholder’s Equity	$51,300

Main Consequence of the Balance Sheet

For distinct reasons, a balance sheet is an essential financial statement-

It furnishes transparency in the capital structure of the businesses: An examination of a company's liabilities and shareholders’ equity provides insight into its blend of debt and equity financing.
It gives information for ratio examination: Vital investment ratios, such as debt-to-equity and current ratios, derive from balance sheet figures.
It expresses the book value of a company over time: The balance sheet furnishes a historical record of assets, claims, and ownership, aiding analysts in gauging the business's book value or tangible worth.
It evaluates working capital and short-term financial health: The equilibrium between current assets and current liabilities highlights the company's short-term solvency and its capacity to fulfil financial responsibilities.

This financial statement holds immense significance, enabling stakeholders—management, investors, lenders, and regulators—to assess a company's financial well-being and inform decision-making.

What are the Restriction of a Balance Sheet?

Though balance sheets offer a glimpse into a company’s financial status, they come with limitations:

Diverse accounting policies can skew the recording and valuation of items like inventory, PPE, and long-term investments.
They rely on subjective management estimates, particularly in areas like inventory valuation and asset impairment.
Window-dressing techniques before reporting dates may artificially enhance appearances, affecting accuracy.
They lack trend analysis found in income statements, making comparisons with previous periods challenging.

Although crucial, relying solely on a balance sheet may not provide a comprehensive view of a business's current financial situation; it should be complemented with other financial statements.

Note: A Balance Sheet defines all the company's assets and liabilities for making the financial records. Through this process, you need software to file and prepare your tax audit reports very easily and smoothly. SAG Infotech's Gen Balance Sheet Software is the most popular software for any CA, CS and tax professional for preparing tax audit forms 3CA, 3CD, balance sheet, profit and loss account statements etc.

What is the Method to Analyze a Balance Sheet?

A balance sheet furnishes extensive data enabling analysts, investors, and stakeholders to evaluate a business’s financial well-being and performance.

Through computation and analysis of key financial ratios, users can gauge a company's liquidity, solvency, efficiency, and profitability.

Here are several pertinent ratios used in conducting balance sheet analysis:

Leverage Ratios

These ratios quantify how much debt a company carries concerning its obligations and the capital invested by shareholders.

Some of the most common leverage ratios are:

Debt-to-Equity Ratio = Total Liabilities / Shareholders’ Equity

Debt-to-Assets Ratio = Total Liabilities / Total Assets

Reduced leverage ratios suggest that a company relies less on debt to fund its activities. Such companies are often seen as less financially risky for investors. Yet, this conservative approach might mean missed opportunities due to limited resources.

Debt can serve beneficial purposes when backed by evidence that a project or business venture will yield favourable outcomes.

Efficiency Ratios

Efficiency ratios showcase a business's effectiveness in generating revenue from its assets. The primary ratios used for this analysis include:

Total Asset Turnover = Revenue / Average Total Assets

Inventory Turnover: Cost of Goods Sold / Average Inventory

A higher number shows more significant efficiency in utilizing the assets to produce sales.

Liquidity Ratios

Such ratios estimate the short-term financial viability of a business in meeting its current obligations.

Key ratios include:

Current Ratio = Current Assets / Current Liabilities

Quick Ratio = (Current Assets – Inventory) / Current Liabilities

A higher number demonstrates more significant liquidity levels and short-term financial health.

Profitability Ratios

These ratios indicate the amount of revenue a company generates concerning the equity or assets required for its operations. Examples include:

Return on Assets (ROA) = Net Income / Average Total Assets

Return on Equity (ROE) = Net Income / Average Shareholders’ Equity

Elevated ratios indicate increased potential for generating profits from assets and equity.

Analyzing these ratios over time and benchmarking them against industry standards allows analysts to delve deeper into a company's operational and financial performance using its balance sheet.