What Is The Balance Sheet And How To Analyze It?

What is a balance sheet?

A balance sheet, also called the Statement of Financial Position, acts as a snapshot of the company’s financial position at a certain point of time. It reports the assets and the liabilities of a company; in simple words, it shows what the company owns and is owed.

It has two formats with both providing the same information either T-shape or Vertical shape as seen below.

When comparing balance sheets from different companies, it is easy to become confused; therefore, try to always read it from the 10-K form. The 10-K is required to be filed with the SEC and summarizes financial decisions, internal controls, investment strategies, etc which has almost the same style and terms for all companies.

Balance sheet form

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Balance sheet 10-K form

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What are the components of the Balance sheet?

The main accounting equation that balances the statement is that

Assets=Liabilities+Shareholders' Equity==Current Assets+Noncurrent Assets=(Current liabilities+Noncurrent liabilities)+(Capital+Retained Earnings)

The assets part, as seen in the equation, is divided into current assets and noncurrent assets:

Current Assets: they are more liquid such as cash and equivalents including assets that have short-term maturities of less than 3 months or marketable securities, inventories, and accounts receivables which are the balances that are still not paid minus bad debts

Non-Currents: Less liquid assests such as properties, land, and Goodwill which is the additional amount a company pays more than the book value of the target company.

Then the liabilities are also divided into the current and long-term liabilities:

Current liabilities: They include the accounts payable (AP), Notes Payable, Current Portion of Long-term debt

AP: which is the amount of credit that the company is to pay to its suppliers,
Notes payables: other short-term obligations other than AP
Current portion of long-term debt: the portion of long-term debt due within this year.

Non-current Liabilities: They include bonds payable, and long-term debt:

Bonds Payable: Include the amortized amount of the company’s bonds
Long-term debt: includes the total amount of long-term debt less the current portion if present under current liabilities. This account is derived from the debt schedule.

Then the shareholders’ equity (also called stockholders’ equity) part:

Shareholder’s Equity: It shows the preferred and common stocks including the number of shares outstanding, paid-in capital and any additions, and Retained Earnings.

The Retained earnings: the remaining amounts of profits after paying all costs, taxes, and dividends left for reinvestments in the company, and it is up to the management whether to retain earnings or to distribute them as dividends (that can be found in the statement of cash flow).


How is the Balance Sheet used in Financial Analysis?

The balance sheet is used to calculate several financial ratios that help in studying the company’s financial status and efficiency in managing its finances including the liquidity, leverage, efficiency, and rates of return such as computing the current ratio, the debt to equity, the asset turnover ratio, and the return on equity. For example, Changes in balance sheet accounts are also used in the cash flow statement to compute cash flow. A positive change in plant, property, and equipment, for example, is equivalent to capital expenditure less depreciation expense. If depreciation expense is specified, capital expenditure can be computed and reported as a cash outflow in the cash flow statement under cash flow from investment.

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