A balance sheet provides a snapshot of the financial standing of a company. It’s considered to be one of the four main financial statements, along with income statement, retained earnings statement, and cash flow. Each balance sheet has three parts: assets, liabilities, and stockholders’ equity. There is an algebraic relationship between these three categories, which is called accounting equation. According to the accounting equation, assets is equal to liabilities plus stockholders’ equity.
Assets are the physical (tangible) and non-physical (intangible) resources that a company owns. They are classified under two major categories: current and long-term. Current assets refer to any kind of assets which are equivalent to cash or can be converted to cash within one year. For example: cash, account receivable, inventory, and short-term investments. Conversely, long-term assets include those assets which are used for more than year. Some of the examples of long-term assets are: long-term investment, equipment and manufacturing plant, any capital investment, and real estate property.
Liabilities are the second part of a balance sheet and refer to what the company owes. Like assets, they are classified under two main categories: current and long-term. Current liabilities consist of those charges that the company should pay out within one year. For instance, accounts payable like bills, insurance, and rent. However, long-term liabilities are obligations that a company should meet over a period exceeding one year. For example, bonds, mortgages, and loans are among the long-term liabilities.
Stockholders’ equity shows what the owners and stockholders own in the company. This portion of the balance sheet reports how much funding a company has received in exchange for its shares, paid-in-capital, and retained earnings. Its value is calculated by subtracting assets of a company from its liabilities, since assets is equal to liabilities plus stockholders’ equity. For instance, if a company’s total assets are $1,000 and its total liabilities $600. According to the accounting equation the company’s y’ equity is $400.
Balance Sheet Financial Ratios
Among the important financial ratios which are used to analyze a company's balance sheet are: current, quick, and debt-to-worth ratios. A current ratio is current assets divided by current liabilities that measures solvency. For example, a current ratio of 1.50 means for every $1 of current liabilities, the company owns $1.50 in current assets to satisfy them. Quick ratio is the sum of the cash and accounts receivable divided by current liabilities which measures liquidity. Finally, to measure financial risk of a company, financial managers and analysts may use a deb-to-worth ratio, which is total liabilities divided by net worth. Consider: a company has a debt-to-worth ratio of 1.20. It means for every $1 of net worth that the company's owners have invested, the company owes $1.20 to its creditors.
- “Financial Accounting: Tools For Business Decision Making”; Kimmel, Weygandt, and Kieso; 2009
Dr. Ned Gandevani holds his Master of Business Administration and Ph.D. degrees in finance. He has authored four published books in investment and trading topics and has written for "Technical Analysis of Stocks and Commodity," "Futures" and "Stocks, Futures and Options (SFO)" magazines. Dr. Gandevani currently teaches finance and MBA courses at several universities in the U.S.