What is the Balance Sheet?

Definition of Balance sheet.

The balance sheet is one of the three basic financial statements, and it is essential for financial modelling and accounting. The balance sheet shows the overall assets of the organization as well as how those assets are financed, whether through debt or stock. A statement of net worth or a statement of financial status are other terms for the same thing. The fundamental equation that the balance sheet is founded on is Assets = Liabilities + Equity.

As a result, the balance sheet is split into two parts (or sections). The balance sheet's left side lists all of a company's assets. The balance sheet shows the company's obligations and shareholders' equity on the right side.

There are two types of assets and liabilities: current assets and liabilities and non-current (long-term) assets and liabilities. Inventory, cash, and trades payables are all placed in the current section before illiquid (or non-current) accounts like Plant, Property, and Equipment (PP&E) and Long-Term Debt.

How is the Balance Sheet Prepared? Structured

Organizations and industries will have slight variations in their balance sheets, as with all financial statements. However, in most balance sheets, there are a few "buckets" and line items that are virtually always included. We go over the most frequent line items under Current Assets, Long-Term Assets, Current Liabilities, Long-Term Liabilities, and Equity in a quick overview.

Current Assets

Cash and Equivalents

Cash, the most liquid of all assets, is listed first on the balance sheet. Cash Equivalents are assets with short-term maturities of less than three months or assets that the corporation can liquidate on short notice, such as marketable securities, and are included in this line item. In the footnotes to the balance sheet, companies will typically disclose what equivalents they include.

Accounts Receivable (A/R)

This account contains the amount of all unpaid sales revenue, minus any allowances for doubtful accounts (which generates a bad debt expense). This account drops when corporations recover accounts receivables, but cash increases by the same amount.

Inventory

Raw materials, work-in-progress goods, and finished goods are all included in inventory. This account is used by the corporation to report sales of products in the income statement, usually under cost of goods sold.

Non-Current Assets

Intangible Assets

All of the company's intangible fixed assets, which may or may not be traceable, are included in this line item. Patents, licenses, and secret formulas are examples of identifiable intangible assets. Brand and goodwill are examples of unmeasurable intangible goods.

Property, Plant and Equipment (PP&E)

Property, Plant, and Equipment (PP&E) is a term used to describe a company's physical fixed assets. Net of accumulated depreciation, the line item is recorded. Some businesses will categories their PP&E according to the numerous sorts of assets they own, such as land, buildings, and various types of equipment. Except for land, all PP&E is depreciable.

Current Liabilities

Current Portion of Long-Term Debt

This account may or may not be combined with Current Debt, as mentioned above. While they may appear to be the same, the current portion of long-term debt is the portion of a loan with a maturity of more than one year that is due this year. For example, if a corporation takes out a 5-year bank loan, this account will include the portion of the loan due the following year.

Current Debt/Notes Payable

Non-AP commitments that are due within one year or one operating cycle of the company are included (whichever is longest). There is also a long-term variant of notes payable, which contains notes with a maturity of more than one year.

Accounts Payable (A/P)

Accounts The amount a corporation owes suppliers for commodities or services acquired on credit is referred to as payables, or AP. As the company pays off its accounts payable, the cash account decreases by the same amount.

Non-Current Liabilities

Bonds Payable

The amortized amount of any bonds the company has issued is included in this account.

Long-Term Debt

The whole amount of long-term debt is kept in this account (excluding the current portion, if that account is present under current liabilities). The debt schedule, which shows all of the company's outstanding debt, interest expense, and principle repayment for each period, is used to create this account.

Shareholders’ Equity

Retained Earnings

This is the entire amount of net income retained by the company. A company's net income can be used to pay dividends at any time. Any money left over (or over) is added to (or subtracted from) retained earnings.

Share Capital

This is the amount of money invested in the company by shareholders. Shareholders often contribute money into a firm when it is first founded. For example, suppose an investor establishes a company and invests $20 million in it. Cash (an asset) increases by $20 million, while Share Capital (an equity account) increases by $20 million, bringing the balance sheet into balance.

In financial modelling, how is the balance sheet used?

This statement is an excellent tool for assessing a company's financial situation. The balance sheet can be used to produce a variety of financial ratios that can be used to determine how well a firm is functioning, how liquid or solvent it is, and how efficient it is.

The cash flow statement uses changes in balance sheet accounts to compute cash flow. For example, capital investment minus depreciation expense equals a positive change in plant, property, and equipment. Capital expenditure can be computed and reported as a cash outflow under cash flow from investing in the cash flow statement if depreciation expense is known.

The Balance Sheet's Importance

For a variety of reasons, the balance sheet is a critical financial statement. It can be examined separately or in conjunction with other financial statements such as the income statement and cash flow statement to obtain a complete picture of a company's health.

The following are four key financial performance indicators:

1. Liquidity - A company's liquidity is determined by comparing its current assets to its current obligations. So that the corporation can meet its short-term obligations, current assets should exceed current liabilities. Liquidity financial measures such as the Current Ratio and Quick Ratio are examples.
2. Leverage - The way a firm is financed can reveal how much leverage it has, which can reveal how much financial risk it is taking. Leverage on the balance sheet is commonly measured by comparing debt to equity and debt to total capital.
3. Efficiency - By combining the income statement and the balance sheet, you can determine how effectively a company uses its assets. The Asset Turnover Ratio, for example, is calculated by dividing revenue by the average total assets to see how efficiently the organization converts assets into revenue. The working capital cycle also demonstrates how successfully a business manages its cash in the short term.
4. Return Rates - The balance sheet can be used to assess how successfully a business earns profits. Divide net income by shareholders' equity to get Return on Equity (ROE), divide net income by total assets to get Return on Assets (ROA), and divide net income by depreciation to get Return on Depreciation (ROD).

Format of Balance sheet:

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