Financial Statement Basics: What is a balance sheet?
Financial Statement Basics: What is a balance sheet?
What the financial
world refers to as "financial statements" are four documents: the
balance sheet, income statement (or profit and loss statement), cash flow
statement, and statement of owner's equity.
Each is intertwined
with the others and required to conduct a thorough analysis of a company's
financial status.
The balance sheet
displays a company's financial situation as of a particular date. It consists
of the owner's equity, obligations, and assets.
Equities are rights or
claims against the resources that a firm owns as assets. An organization with
$100,000 in assets will also have $100,000 in claims against those assets.
Assets = Equities is the connection, expressed as an equation.
Equities can be
further broken down into claims made by owners or claims made by creditors.
Liabilities refer to claims made by creditors, whereas owner's equity refers to
claims made by owners. After that, the formula can be expanded to read assets =
liabilities plus owner's equity.
The "fundamental accounting equation" states that assets must equal the total of the liabilities plus the owner's equity. The fundamental structure of a balance sheet, which illustrates the overall flow of this equation, is shown in Table 1.
Assets
As
shown in Table 1, the asset component of the balance sheet can often be divided
into three categories: current assets, fixed assets, and other assets.
Current
assets are funds and other resources that can be expected to be converted into
cash, sold, or used by the company's operations within a year of the balance
sheet date.
Accounts
receivable, inventories, marketable securities, and prepaid expenses are a few
examples of other current assets.
The
ability of a corporation to meet its obligations and expenses depends heavily
on its current assets, which are also its most liquid assets (liquidity refers
to how easily these assets may be turned into cash).
Fixed
assets are material possessions that are employed by the company, have a long
lifespan, and are not intended for sale. They could consist of lands,
structures, machines, tools, furnishings, and fittings. These assets, which are
needed to run the company but are less liquid,
Intangible
assets, often known as other assets or intangible property, can be goodwill,
patents, and/or trademarks. Various notes due from officers or staff members of
the corporation, as well as the cash surrender values of insurance, may also be
included. They are also less liquid.
Liabilities
The
opposite of current assets is current liabilities. They are debts that should
be able to be settled within a year, either with current assets already on hand
or with other current liabilities.
Accounts
payable, the utilization of a credit line, wages and salaries, taxes, and
current maturities of long-term debt are some examples of current obligations.
When
assessing a company's liquidity, or its capacity to meet payments projected to
become due within a year, the link between current assets and current
liabilities is crucial.
The
chance of paying current liabilities is positive when current assets exceed
current liabilities; when the opposite is true, liquidity may be an issue.
Obligations
with a one-year payoff horizon are referred to as long-term liabilities. These
obligations frequently take the form of a mortgage, car note, or another type
of debt connected to bank funding.
Equity
Owner's
equity, which represents the owner's claim on the company, is calculated by
subtracting all liabilities from all assets. It is the value that remains after
deducting all liabilities from all assets.
Owner's
equity is essentially an ownership stake that rises with business success or
extra paid-in capital and falls with business failure or capital withdrawals.
The ideal owner's equity figure is one that is positive and is derived through
profits.
The
second item in this series will address the important parts of the income
statement and how they relate to equity performance, costs, and profitability.
Liquidity
Being
able to see the large picture via the specifics of a company's financial
statements, or in this case, the company's balance sheet, is essential for
managing a business for financial health.
It's
critical to understand a company's liquidity and leverage as of the date given.
Leverage is the term for the amount of borrowed money that a business uses to
increase the size of its asset base.
A
company's balance sheet condition will demonstrate its capacity to research and
assess financing choices, pay short-term obligations on time, and tolerate
unforeseen costs.
A
comparative balance sheet for the two years of 2020 and 2021 that finish on
December 31 is shown in Table 2. As we continue our analysis, we will refer to
this table.
*Take note that the basic accounting equation is balanced for each period: as of December 31, 2021, total assets were $350,000, total liabilities were $200,000, and total equity was $150,000. The year 2020 will be the same.
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