A balance sheet is a snapshot of a company’s financial health at a moment in time. It shows what a company owns (assets) and what it owes to others (liabilities and shareholder equity).
This is an extremely important document for investors, business owners, and finance teams. It’s also a crucial component of the financial model that supports a wide range of analysis, including discounted cash flows and value at risk models. In addition, balance sheets are used by accountants to prepare tax returns and for other reporting purposes.
The three main sections of a balance sheet are assets, liabilities, and shareholder’s equity. Each of these categories is arranged in order of their maturity and is meant to balance out the other two sections. A balance sheet adheres to the accounting equation, which equates assets with the sum of liabilities and shareholders’ equity.
Accountants and finance teams make use of a balance sheet to quickly calculate key metrics, like liquidity and debt-to-equity ratios. They can also analyze the trends of these numbers over time by presenting comparative balance sheets for multiple periods.
Liabilities are listed in order of their maturity, starting with current liabilities and then long-term liabilities. This section includes any money that a company owes to creditors or other parties that it must pay within the next year, such as accounts receivable and inventory. It also includes the value of a company’s fixed assets that it cannot convert to cash within the next year, such as land, buildings, and equipment. These assets depreciate over time, and the decline in value is recorded as a cost on the income statement.
Lastly, the equity section contains the residual ownership interest of company shareholders after all of the company’s liabilities are paid. This is comprised of common stock and preferred stock. Preferred stock is a type of equity that gives investors a higher claim on the company’s assets and earnings than common stock. Common stock is what most people buy when they invest in the public market. A company’s shareholders’ equity can be increased by net income, by new investments in the company, and by dividend payments. It can be decreased by losses, by share repurchases, and by other means.
While most of the information on a balance sheet is measurable and objective, there are a few areas that require professional judgement to report accurately. For example, the value of cash is measurable and fairly objective, as are the amounts due from debtors and inventory. However, the value of some assets, like real estate and equipment, can be subject to estimation and interpretation. Also, different accounting systems and ways of dealing with depreciation can impact the figures on a balance sheet. Therefore, it’s important to carefully examine the footnotes of a balance sheet in order to understand how the figures were calculated. Bilanz