Balance Sheet Analysis: Best Use and Presentation
by Aaron Nelson on October 21, 2014
The balance sheet is one of three critical statements regarding the financial health of a business. Investors rarely do a balance sheet analysis because of its appearance and lack of explanation. Realistically, it is a single moment snapshot of a company showing the assets, liabilities, and available equity.
The “ounce of prevention” necessary to stay in business will appear among many figures in a company balance sheet. Management, investors, and shareholders should read, analyze, and assess the information that appears on a company balance sheet. It helps to place a focus on details about the financial health of a company.
The structure of accounts on the balance sheet is quite simple: Assets = Liabilities + Equity. The information forms a T-bar with left side listing and totaling assets of the business. The right side presents accounts of liability and equity. Totals of each side must be equal.
What Goes Where
The formula of the balance sheet indicates money in use for company operations and covers the financial obligations that are outstanding. It also shows equity investments. All liabilities and retained earnings must be equal to assets available.
There’s a tendency to look at assets and liabilities differently, but the fact is that assets drive the business operations forward and support both liabilities and equity. Shareholder equity is the initial cash investment to start a business and retained earnings, which are a source of company funds.
Types of Assets
Management must be alert and able to appraise credit policy and credit risks. The assets that are easy to convert into cash include:
• Cash and cash equivalents
• Accounts receivable
Cash is the most valuable asset and includes currency, checks, and treasury notes. If you can sell, collect, or legally liquidate accounts receivable, the result is cash and makes the case for calling these accounts an asset. Inventory kept on the premises or in abeyance and sold to a third party for cost, discount, or retail price becomes a cash asset.
Non-current assets do not easily generate cash. They take a full year or more to produce cash or an equivalent. These assets include tangible items (machinery, computing devices, or real estate). Intangible assets are rarely seen elements (trademarks, patents, copyrights, and general goodwill) that are not concrete or physical, but valuable nonetheless.
Liabilities appear on the right side of a balance sheet. They represent money a business owes to outside independent parties. These obligations could be current or long-term.
Long-term liabilities include obligations that will last more than one year beyond the date of the balance sheet. Current liabilities are those due within twelve months and common examples are:
• Accounts payable
• Current year interest on term loans
Shareholder equity also has a right side position and represents initial infusion of cash into the business. When the balance sheet generates from a computer, the layout is a bit different. This layout is a stack of sections with assets appearing first and liabilities plus equity below.
Balance Sheet Analysis
The bottom line is important for analysis, but should never subrogate supporting details that come first. The balance sheet package helps others understand a business and its operations. Management, shareholders, and investors must know how to read, analyze, and use this document. An addendum can translate most financial entries into ratios or percentages.
Financial strength and major activity ratios help understand methods in use to meet and leverage financial obligations. Working capital and debt to equity ratios explain the health of a company. contact us for further information about presenting financial stability relating to a business