A balance sheet is a financial statement that summarises a company’s financial position at a specific time. It presents information on the company’s assets, liabilities, and shareholders’ equity. This statement is used by various stakeholders, including lenders, investors, and borrowers, to assess a company’s financial health and ability to repay loans.
To evaluate a company’s financial position, investors and analysts use the balance sheet in conjunction with other financial information. The balance sheet provides a snapshot of a company’s financial health at a specific moment in time, so it’s important to analyse trends and changes over time to fully understand a company’s financial standing.
A balance sheet includes three main sections: assets, liabilities, and shareholder equity. The balance sheet equation is a simple formula that expresses the relationship between these sections:
- Equity = Assets – Liabilities
- Assets = Liabilities + Equity
- Liabilities = Assets – Equity
Overall, the balance sheet is a crucial financial statement that provides a snapshot of a company’s financial position and is used to make important financial decisions by various stakeholders.
What are assets?
Assets are resources that a company owns and can use to run its business operations. These resources can be both short-term and long-term and include liquid assets like cash, bank funds, trade debtors, loans to other entities, and inventory, as well as fixed assets such as buildings, equipment, and vehicles. Additionally, assets may also include intangible items like trademarks and goodwill.
Assets have a measurable value that can be expressed in monetary terms. They can be categorised into different types, including current assets, fixed or non-current assets, and intangible assets.
- Current assets are those that can be easily converted into cash, such as bank accounts, inventory, short-term deposits, investments, pre-payments, and accounts receivable or trade debtors.
- Fixed or non-current assets are those that are not easily converted into cash and include motor vehicles, equipment, and buildings.
- Intangible assets are those that have no physical presence, such as trademarks, intellectual property, and goodwill.
What are Liabilities?
Liabilities refer to the money that a company owes to its creditors, suppliers, and the government for goods or services that have already been received but have not been paid for yet. This can also include amounts received in advance for services that will be provided by the company in the future, depending on the industry.
There are two types of liabilities: current liabilities and long-term liabilities. Current liabilities are expected to be paid off within one year, while long-term liabilities are expected to be paid off over a longer period.
- Current liabilities include overdrafts, credit card balances, trade creditors, payroll liabilities such as unpaid wages, PAYGW, and superannuation, as well as ATO liabilities like GST, income tax, and FBT.
- Non-current liabilities are longer-term obligations, such as warranties, loans, leases, and mortgages.
The primary purpose of recording liabilities on the balance sheet is to provide accurate information about the company’s financial obligations that are due in both the short and long term. Regular review and reconciliation of key accounts on the balance sheet by a qualified bookkeeper help to assess the company’s financial health and its ability to meet its obligations as they come due.
What is Equity?
Equity refers to the portion of a company’s assets that is owned by its shareholders. It includes funds contributed by the owners, retained earnings, and dividends.
Changes in the profit and loss accounts can also affect the items on the balance sheet. For instance, providing a service can increase the accounts receivable balance, which in turn increases the company’s assets and equity. On the other hand, taking out a loan or purchasing additional stock can increase the company’s liabilities and reduce its equity.
The balance sheet equation
The balance sheet equation is Assets = Liabilities + Equity. It is crucial to ensure that the balance sheet always balances, meaning that the total value of assets should equal the sum of liabilities and equity.
The equation reflects the amount of money that would be left over if all debts and bills were paid, and all assets were sold on a specific date. This value is known as the owner’s equity.
It is essential to note that the total equity on the balance sheet may differ significantly from the actual market value of the business. Assets are recorded on the balance sheet at their transaction value, which may be very different from their current market value. For instance, an asset purchased for $100,000 in 2002 may have significantly appreciated in value, and it could be worth $250,000 today. Similarly, some assets may be worth less due to depreciation.
While the balance sheet provides vital figures to value a business, it does not include other crucial factors such as market share, location, staff, and future prospects. Therefore, it cannot be solely relied upon to value a company.
Tips For Improving Your Balance Sheet
Are you looking to improve your company’s balance sheet? If so, you can do a few things to make it happen. These include:
- Have a professional bookkeeper (that’s us) review and reconcile key balance sheet accounts, bank, credit card, GST, PAYGW, loans etc., to ensure the figures remain accurate.
- Understand the different types of assets and liabilities on your balance sheet.
- Make sure your assets are adequately diversified.
- Review your debt levels and terms regularly.
- Keep an eye on your cash flow.
- Have a contingency plan for unexpected expenses.
Need more information?
The balance sheet is a crucial financial statement that provides a comprehensive view of a company’s financial health. A robust balance sheet allows a business to have the flexibility to withstand challenging times, while a weak balance sheet can limit its operations. Understanding how to analyse and interpret a balance sheet can help you gain insights into your company’s financial situation and make informed decisions about investment, diversification, expansion, or restraint.
If you need assistance with analysing, reconciling, and comprehending your balance sheet, contact Gecko Bookkeeping for help! Gecko offers free consultations to help small businesses comprehend their financial status and balance sheets. Get in touch to gain a complete understanding of your business’s performance and financial position.