A balance sheet is a statement of a company’s financial condition. It is drawn up at the end of each accounting period, and while it is created by accountants in the finance department, it forms part of the annual report, which is distributed to all shareholders.
A balance sheet is one of the three parts of a publicly traded company’s financial statements, the other two being the income statement and the cash flow statement. Though every company needs one.
The balance sheet summarizes a company’s assets, liabilities, and shareholder equity at a given moment in time.
It’s like a photo album that shows you what your house looked like when you moved in and what it looks like now.
In this article, we will take a look at what a balance sheet is, the different types of balance sheets, how to read a balance sheet, and some top tips that you can follow in order to maintain a healthy balance sheet for your business.
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The importance of a balance sheet
As mentioned, a balance sheet is a snapshot of your company’s financial health. It shows you where you stand in terms of assets and liabilities, and it helps you understand how healthy your business is.
A balance sheet can be very useful for several reasons:
- Shows where all the money comes from and where it goes.
- Helps you determine whether or not you have enough cash flow to keep operating.
- Gives you an idea of what kind of cash flow you need to stay afloat as a company.
- Helps investors to assess the company’s overall financial health.
- Helps you understand how much money is available for new projects.
This information can help you make changes to your business, and it also gives you peace of mind that everything is going well.
It can be an essential document for many occasions, including applying for licenses, compliance, and loans.
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Types of balance sheets
There are two types of balance sheets:
Unadjusted Balance Sheet
The unadjusted balance sheet is the simplest form of a balance sheet. It is also known as the simple or standard balance sheet. This type of balance sheet shows only what is owned, what they owe, and the difference between these two amounts.
It does not take into account any other factors that may be relevant to their financial situation, such as depreciation or any other adjustments that may need to be made to get a more accurate reflection of their net worth.
Adjusted Balance Sheet
An adjusted balance sheet is a financial statement that has been modified. The most common adjustments are depreciation and amortization, which can be included on the balance sheet in order to provide a more accurate picture of assets and liabilities.
The main purpose of an adjusted balance sheet is to make it easier for investors to see how well a company has performed over time. For example, if a company buys another company, then it must record the value of that acquisition on its balance sheet.
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Assets, liabilities, and stockholders’ equity
Balance sheets are a way to see how much value a company has. They’re organized into three sections:
Assets are things like cash, equipment, or inventory that the company owns. Liabilities are things like loans or unpaid bills. And equity is the difference between the two (the amount of money the company has left over after taking out its debts).
Balance sheet layout
A balance sheet shows you not only how much money a company has on hand, but also what it owes. The balance sheet is laid out in a particular way so that you can see at a glance whether a company is in good financial standing.
On the left side of the balance sheet, you’ll find the assets section (the things that the company owns). On the right side of the balance sheet are liabilities, the debts that the company has to pay off at some point.
As explained earlier, the difference between assets and liabilities is called equity (or net worth). When this number is positive or zero (meaning assets are greater than liabilities), it means that there’s enough equity for investors to feel confident investing in the company’s future growth plans. If there’s negative equity (liabilities exceed assets), then investors might be worried about whether they’ll get their money back.
Balance sheet vs, income statement vs, cash flow statement
Balance sheets, income statements, and cash flow statements are all financial statements that companies use to report their financial performance. However, it’s critical that you understand the differences.
The balance sheet is a snapshot of a company’s assets, liabilities, and equity at a point in time. It’s like a photograph of what the company owns and owes at any given moment. The balance sheet also includes an income statement for the period ending with the snapshot date.
An income statement shows how much revenue (income) and expenses (costs) a company had over a specific period of time, such as a year. It also shows how much profit or loss the company made during that period. A company can show its performance for one year or for several years combined into an annual report.
Cash flow statement
A cash flow statement shows how much money came into and went out of a business over time. This is important because it shows if there is enough money coming in to cover all expenses and make a profit without borrowing more money or having to sell stock (which would dilute ownership).
What’s included in a balance sheet?
A lot of people get confused about what goes into their balance sheets because they think it’s just a list of items like “cash,” “inventory,” and “accounts receivable.” However, there are actually seven different categories on a balance sheet:
- Cash: Cash is the most basic item on your balance sheet. It includes all the money you have in your bank account and any other investments that you can easily access.
- Accounts Receivable: Accounts Receivable is the total amount of money that is owed to a company. (It’s an asset on the balance sheet because it can be used to pay debts).
- Inventories: Inventories are assets that a business owns for the purpose of selling them in the future. They’re usually made up of raw materials and finished goods but can also include things like work in progress.
- Fixed Assets: Fixed assets are the assets that you own and can’t easily get rid of. These include things like property, plant, and equipment (PP&E).
- Intangible Assets: Intangible assets, or non-physical assets, are things like patents, copyrights, trademarks, and goodwill. They are things that can’t be seen or touched, but they’re still valuable.
- Current Liabilities: Current liabilities are the debts that are due within one year. They’re called current because they’ll be paid off in the near future. This can include anything from accounts payable to short-term loans.
- Long Term Debt: The long-term debt section of a balance sheet describes any money that the company owes to creditors that isn’t due within the next 12 months. The most common types of long-term debt are mortgages, bonds, and promissory notes.
How to analyze a balance sheet
There are two main ways that you can analyze a balance sheet, horizontally and vertically.
Horizontal analysis of a balance sheet
Horizontal analysis is a way to look at the balance sheet of a company. The horizontal analysis focuses on what is called a statement of cash flows, which is a way of looking at all the money that comes in and goes out of a company as a whole.
When analyzing a horizontal analysis balance sheet, you should look for changes in liquid assets, accounts receivable, and inventory levels. If these are all increasing over time, it could indicate that the company is having trouble paying its bills on time and needs to increase its cash reserves.
A horizontal analysis will show you how much cash came in and went out over time, as well as how much debt was taken on during that time period.
Vertical Analysis of a Balance Sheet
Vertical analysis is a method of financial statement analysis that analyzes a company’s balance sheet by looking at individual line items as opposed to viewing the entire balance sheet as a whole as you would with horizontal analysis.
The vertical analysis allows investors to look at each asset and liability separately, which can help business owners and investors understand how those individual components affect the overall health of the company and its ability to pay back its debts.
The term “vertical” refers to the fact that you are going through each part of the balance sheet one item at a time, rather than going across from left to right like the horizontal analysis. For example, an investor might look at each asset on the balance sheet individually instead of just looking at all assets combined.
The balance sheet presents the financial health of your company. This is why you’ll have to learn how to present financials for s startup with no revenue. Check out this video where I have explained how to get that done and impress your investors.
Tips for keeping a healthy balance sheet
A healthy balance sheet is one of the most important things for your business. It’s an indication of the financial health of your company and gives you an idea of how well you’re doing.
When you’re looking at your balance sheet, you need to make sure that it has a positive net worth (assets minus liabilities). If it doesn’t, then you may need to take action to fix that.
Here are some tips you can use to help keep a tip-top balance sheet:
- Keep an eye on your cash flow. You want to be sure that you can pay your bills on time and have enough cash to cover any unexpected expenses that come up.
- Keep tabs on your debt to equity ratio, the amount of money you owe versus the amount of money you own. If this ratio becomes too high, it could indicate financial trouble ahead.
- Be sure to keep up with all tax obligations related to the information in your balance sheet, including filing taxes on income from assets and paying taxes on debt incurred from liabilities.
- Perform a SWOT analysis to find strengths, weaknesses, opportunities, and threats within your business, but you can only do this when you look at these elements objectively. One way to do this is to perform a SWOT analysis.
- Don’t spend more than you earn. It’s simple, but it’s true: if your income is less than your expenses, chances are good that you won’t be able to keep up with all of those bills.
- Slow-paying debtors can strangle the cash flow of a company. Ideally, you want accounts to be moving relatively quickly. If they are not, this could be an area worth looking into for sure.
- Make sure that any loans are paid off on time.
There are many business forms used in various lines of business and for different purposes.
What makes the balance sheet so important is that it tracks the changes that take place within an organization during a given year or any time period.
Every business owner should have a basic understanding of how to read and effectively work with a balance sheet. It can help you make crucial financial decisions, evaluate how your business is doing, and provide you with tools for achieving your long-term goals.
In this article, we have explained what a balance sheet is and the different types of balance sheets, and hopefully illustrated the importance of having a balance sheet for your business.
Also, be sure to follow our top tips above to help you maintain a healthy balance sheet so you can grow and expand your business into the empire that it deserves.
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