A Balance Sheet, one of the primary financial statements of an organisation, does what is says on the tin – it’s a sheet, or statement, that balances!
What balances? The assets of the company balances with the liabilities and equity of the entity.
What does all that mean in English?
If you think of your own personal situation, if I asked you what assets you might own or control in your life, you may say: house, car, furniture, TV, DVD player, etc. If I then asked how you might pay for these items, you may say a mortgage for a house, a loan for a car and a credit card is used to pay for furniture, etc.
It is not that dis-similar in a business.
Assets are what a company uses to generate cash. They are categorised into non-current assets, which last for more than one year, and current assets, which last for less than one year.
Non-current assets are the larger and more expensive items that the business owns or controls, including land and buildings, motor vehicles, office furniture and IT equipment.
Current assets include debtors (customers who owe us money), cash in the bank and any stock the company holds to sell to customers.
Liabilities show what we owe on what we own or control in a business.
Again, liabilities are split into non-current liabilities, those which are due in more than one year such as a bank loan, and current liabilities which are those owed in less than one year, such as payment to suppliers and HMRC.
Equity, also called Share Capital and Reserves, shows the share capital, prior year reserves and also the retained profits from the current year.
Investors focus heavily on reviewing a company’s Balance Sheet. Therefore how do we know if a company is healthy and strong from its Balance Sheet?
Some tips to help you analyse a Balance Sheet:
- Are there sufficient short-term (i.e. less than one year) assets to cover the short-term liabilities? If so, this suggests a more financially healthy company.
- How large are the non-current liabilities? In the future, these will become current liabilities. If the non-current liabilities are disproportionately large, this could provide advance warning of future issues.
- What is the proportion of debt (shown in liabilities) compared to equity? A Balance Sheet is deemed to be more financially healthy the higher the proportion of equity to debt.
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