How to Read & Understand a Balance Sheet

The shareholder equity section displays the company’s retained earnings and the capital that shareholders have contributed. For the balance sheet to balance, total assets should be equal to the combined total of liabilities and shareholder equity. The balance sheet includes information about a company’s assets and liabilities, and the shareholders’ equity that results. These things might include short-term assets, such as cash and accounts receivable, inventories, or long-term assets such as property, plant, and equipment (PP&E).

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If you are new to HBS Online, you will be required to set up an account before starting an application for the program of your choice. If this balance sheet were from a US company, it would adhere to Generally Accepted Accounting Principles (GAAP), and the order of accounts would be reversed (most liquid to least liquid). By looking at the sample balance sheet below, you can extract vital information about the health of the company being reported on.

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In addition, you might want to voluntary prepare a balance sheet to help you monitor the assets, liabilities and net worth of your company. Knowing how to prepare or read and understand a balance sheet is a critical skill for all small business owners. A balance sheet is part of your company’s financial statements which also include the income statement, the statement of shareholder’s equity and the cash flow statement. For example, the balance sheet is connected to the cash flow statement as the cash balance that appears on the balance sheet is the ending balance used in the cash flow statement. By comparing your business’s current assets to its current liabilities, you’ll get a clearer picture of the liquidity of your company. In other words, it shows you how much cash you have readily available.

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For example, a manufacturing firm will carry a large number of raw materials, while a retail firm carries none. The makeup of a retailer’s inventory typically consists of goods purchased from manufacturers and wholesalers. Yes, these statements are critical when seeking financing, as lenders and investors want to assess the company’s financial stability and profitability before making commitments. However, small businesses may benefit from more frequent reports, like monthly, to better manage finances. Although a Balance Sheet and Income Statement may be produced using more detail by modern accounting software like Wafeq, this is essentially all that is available. If you’ve read thus far, you should now know how to read your financial accounts confidently.

The total value of a company’s assets will always equal the sum of its liabilities and shareholders’ equity; in other words, the balance sheet will always balance. This is a result of the fundamental accounting principle of double-entry bookkeeping, where every transaction is recorded on both sides of the equation. A balance sheet, an income statement, and a cash flow statement are all used to analyze and assess the health of a company. A balance sheet shows a company’s assets, liabilities, and equity at a specific point in time. An income statement shows a company’s revenue, expenses, gains and losses over a longer period of time. A third statement, called a cash flow statement, works in tandem with the income statement and balance sheet to provide information about the financial health of a company.

It shows how the revenues are transformed into the net income or net profit. For example, equipment wears out, vehicles get too old and expensive to maintain, buildings get old, and some assets (like computer systems) become redundant. Depreciation is how the cost of an asset is spread out over its useful life on the income statement as Depreciation Expense. In short, the cost principle says that assets shouldn’t be reported at more than what they cost. Conservatism could also mean that the balance sheet should report assets at less than what they cost.

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1. If you’ve found that your balance sheet doesn’t balance, there’s likely a problem with some of the accounting data you’ve relied on.
2. Although a Balance Sheet and Income Statement may be produced using more detail by modern accounting software like Wafeq, this is essentially all that is available.
3. He may want to take a look at his inventory, and see what he can liquidate.
4. Whether you’re a business owner, employee, or investor, understanding how to read and understand the information in a balance sheet is an essential financial accounting skill to have.

What Is Included in the Balance Sheet?

1. Investors, business owners, and accountants can use this information to give a book value to the business, but it can be used for so much more.
2. You also don’t include current assets that are harder to liquidate, like inventory.
3. Balance sheets should also be compared with those of other businesses in the same industry since different industries have unique approaches to financing.
4. Balance sheets are one of the most critical financial statements, offering a quick snapshot of the financial health of a company.
5. In this case, you don’t include assets like real estate or other long-term investments.
6. After enrolling in a program, you may request a withdrawal with refund (minus a $100 nonrefundable enrollment fee) up until 24 hours after the start of your program.

This means that the balance sheet should always balance, hence the name. If what do you mean by balance sheet they don’t balance, there may be some problems, including incorrect or misplaced data, inventory or exchange rate errors, or miscalculations. Do you want to learn more about what’s behind the numbers on financial statements? Explore our finance and accounting courses to find out how you can develop an intuitive knowledge of financial principles and statements to unlock critical insights into performance and potential.

If you are new to HBS Online, you will be required to set up an account before enrolling in the program of your choice. When a balance sheet is reviewed externally by someone interested in a company, it’s designed to give insight into what resources are available to a business and how they were financed. Based on this information, potential investors can decide whether it would be wise to invest in a company. Similarly, it’s possible to leverage the information in a balance sheet to calculate important metrics, such as liquidity, profitability, and debt-to-equity ratio. Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the common or preferred stock accounts, which are based on par value rather than market price.

Shareholders’ Equity

If necessary, her current assets could pay off her current liabilities more than three times over. While the balance sheet focuses on assets and liabilities, the cash flow statement tracks the movement of cash within a company. It provides valuable information about the company’s ability to generate and utilize cash, detailing operating, investing, and financing activities. By examining the cash flow statement in conjunction with the balance sheet, stakeholders can assess the company’s liquidity, solvency, and capacity for growth. Shareholders’ equity is the initial amount of money invested in a business. Long-term liabilities are debts and other non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet.

Shareholder equity is the amount of money that would be left over if the company paid off all liabilities, such as debt, in the event of a liquidation. A balance sheet, along with the income and cash flow statement, is an important tool for investors to gain insight into a company and its operations. It is a snapshot at a single point in time of the company’s accounts—covering its assets, liabilities, and shareholders’ equity.

Depicting your total assets, liabilities, and net worth, this document offers a quick look into your financial health and can help inform lenders, investors, or stakeholders about your business. Based on its results, it can also provide you key insights to make important financial decisions. The current ratio measures the liquidity of your company—how much of it can be converted to cash, and used to pay down liabilities.

Just as assets are categorized as current or noncurrent, liabilities are categorized as current liabilities or noncurrent liabilities. Typically, a balance sheet will be prepared and distributed on a quarterly or monthly basis, depending on the frequency of reporting as determined by law or company policy. Depending on the company, different parties may be responsible for preparing the balance sheet.