How to read a Balance Sheet?
Every share holder receives annual report from the company in which he/she has invested money. You can also check company’s annual report on company’s website or on stock exchange website. Balance sheet is a part of this annual report. Lets read how to read this balance sheet? And, why should you read a balance sheet?
Balance sheet shows state of company’s financial health. It means, what company is owning, and what company is owing. What company owns is asset and what company owes is liability.
There are two parts on balance sheet. On one side, asset is there and, on another side, liability plus equity are there. Total should of these two sides match. So, the formula of balance sheet is:
Asset = Liability + Equity
Asset includes current asset, non-current asset which includes fixed assets, and other assets.
Current asset includes:
- Cash: Cash, bank account
- Inventory: For manufacturing unit, company’s raw material, finished goods, work in progress goods. For retail firm, goods purchased from manufacturer or wholesaler.
- Account receivable: Company often sell products on credit and this credit amount has to be owned to the company by client.
Non-current asset includes:
- Fixed asset includes:
- Equipment
- Buildings
- Land
- Vehicles
- Intangible asset which means trademark, patent, etc.
- Long term investment
Liability includes current liability, long-term liability.
Current liability includes:
- Accounts payable
- Salaries to be given
- Taxes
- Credit card payment
Long term liability means loans which will not be paid within next 12 months.
Equity means shareholder’s equity or owner’s equity. You can calculate this by subtracting liability from asset. Ideally this number should be positive.
Also Read:
Example to understand terms of balance sheet more clearly.
Suppose there is a juice parlour.
Assets would be: Cash, machineries bought, your stalk
Liability would be: Money borrowed to construct the parlour, salaries to be paid
So, when you subtract this liability from asset, you would get the idea what an owner owns.
| Asset | Liability | ||
|---|---|---|---|
| Cash | 2000 | Money to be paid to bank | 2000 |
| Juicer machine | 4000 | Salary to be paid | 1000 |
| Equity of owner | 2000 | ||
| Total | 6000 | 6000 |
So, this total on both sides should match. This is just an example.
Now, when an owner takes loan from a person or bank further, parlour’s cash asset would increase, and his liability would also increase by same amount.
| Asset | Liability | ||
|---|---|---|---|
| Cash | 2000 +4000 | Money to be paid to bank | 2000 |
| Juicer machine | 4000 | Money to be paid to lender | 4000 |
| Salary to be paid | 1000 | ||
| Equity of owner | 2000 | ||
| Total | 10000 | 10000 |
Uses of balance sheet: Why should you read a balance sheet?
- A shareholder can know whether company is in good condition or bad.
- A shareholder can compare company’s balance sheet with its previous year’s to check performance or balance sheets other businesses in same industry.
- A shareholder can know what company’s shares are worth.
- A lender can decide whether to give new money to the company owner. A lender can know whether the owner can repay or no from balance sheet.
- Owner can see how his assets and liabilities have changed in a year map.
- Owner can also make sure if he has enough fund to meet upcoming expenses.
FAQ
What is a good balance sheet?
A strong balance sheet goes beyond simply having more assets than liabilities.
What are 3 main financial statements?
They are:
- balance sheets
- income statements
- cash flow statements
Who benefits from balance sheets?
The balance sheet is particularly helpful in that it keeps both you and your stakeholders informed of your financial standing.
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