The balance sheet is only one component of a company’s consolidated financial statements. It does, however, provide an indication of how healthy a business is at a given point in time. So, whether you are a potential investor, a current business owner, or a financial manager, you are aware that one of the most critical financial statements is the balance sheet. In this article, you will read about the balance sheet report and more features and options about QuickBooks and QuickBooks desktop premier click on these links.
And, because a balance sheet is a snapshot of how your business is doing, knowing your way around one and being able to parse the information it provides is critical. So, here’s an explanation of your balance sheet.
A balance sheet, also known as a statement of financial position, is a financial report that details a company’s assets, liabilities, and shareholders’ equity over a specific time period. In essence, a balance sheet shows what the organization owes and owns over a specific time period. This is critical because the balance sheet report reflects the financial situation of the organization.
Why Every Business Needs a Balance Sheet
In general, the strength of a company can be measured using three broad categories of investment-quality metrics: working capital, asset performance, and capitalization structure.
Working capital is the difference between an organization’s current assets (cash, investments, and annual revenue) and current liabilities (i.e., payables owed to suppliers). Working capital reflects an organization’s ability to manage two critical assets: accounts receivable and inventory, as well as its cash conversion cycle.
Asset performance refers to the ability to take operational resources, manage them, and generate profitable returns. The return on assets (ROA) ratio is a metric used to assess the performance of an organization’s assets.
Capitalization refers to the ratio of debt to equity on a company’s balance sheet.
To truly understand how a business operates, you must first understand the balance sheet and how to calculate the working capital, asset performance, and capitalization of a company.
What Are the Components of a Balance Sheet Report?
A balance sheet is a snapshot in time, not a long-term forecast of fiscal trends. Comparing your balance sheet to previous ones, on the other hand, can help you decipher those long-term trends and results.
The following are the elements and components of a balance sheet and how they work.
The asset section represents what an organization owns and can convert into cash if necessary. This section is divided into subsets and is listed on the balance sheet in the following order of liquidity:
- Money and its equivalents
- Accounts payable
- Expenses paid in advance
- Invested capital (i.e., property)
- Assets can be further subdivided into categories such as:
Current assets can be converted to cash in as little as a year (i.e., accounts receivable, inventory, etc.).
Long-term assets take longer to recoup your investment (i.e., real estate).
Assume you own a fancy chocolate company called “Gold Mountain,” and your assets are as of January 2020, in order of liquidity:
- $1,025 in the bank
- $3,050 in accounts receivable
- $450 in supplies/inventory
Your liabilities will be listed first on your balance sheet (i.e., what a business owes others). Liabilities, like assets, are classified as either current (due within a year) or long-term (the due date is more than a year away).
The liabilities of a company are listed in the following section of a balance sheet. Your liabilities are the sums of money you owe to others, such as recurring expenses, loan repayments, and other types of debt. Current and long-term liabilities are subdivided into liabilities.
Rent, utilities, taxes, current payments toward long-term debts, interest payments, and payroll are examples of current liabilities.
Long-term liabilities include deferred income taxes, long-term loans, and pension fund liabilities.
- Accounts receivable are among your current liabilities (items you bought on credit)
- Employee pay is based on the number of hours worked.
- Loans with a one-year repayment term
- Any outstanding taxes
- Here are some examples of long-term (non-current) debts:
- Loans that do not need to be paid back within a year
- Bonds issued by your firm
- Our fictional chocolatiers’ liabilities could include:
- Accounts Payable $75
- Long-term debt of $1,000
- Total liabilities of $1,075
Shareholder’s Equity/Owner’s Equity
A company’s equity is the amount of money it currently owns. The category is known as “owner’s equity” for sole proprietorships and “stockholders’ equity” for corporations. This section shows the components that business owners/shareholders have.
- The money invested in the business by the owners is referred to as capital.
- Stock, whether private or public
- Retained earnings are defined as all revenue less all expenses since the launch.
- When an owner withdraws money from the company to pay themselves or when a corporation pays dividends to shareholders, equity can fall.
For our fictional chocolatiers, their equity may look like this:
- Capital: $2,500
- Retained Earnings: $5,450
- Drawings: $-4,500
- Total Equity: $3,450
Another method of examining the balance sheet report is vertical analysis. Vertical analysis is a method of reviewing a financial statement by calculating each line as a percentage of the statement’s predetermined base figure.
Vertical analysis, for example, can examine a specific balance-sheet line item as a percentage of total assets.
Classified Balance Sheet
In addition to a vertical analysis, a classified balance sheet is another way to parse your balance sheet. A classified balance sheet is a breakdown of each balance sheet subcategory, resulting in a more nuanced and valuable report. There are no standardized or specific subcategory groupings. Your financial management team, on the other hand, can determine which classifications are appropriate for your short- and long-term goals.
Who Prepares Balance Sheets?
Balance sheets can be prepared by a group of people. For small businesses, this can include company owners or bookkeepers. Balance sheets can also be prepared and reviewed by internal or external accountants.
If a company is publicly traded, public accountants must review balance sheets and conduct external audits. Furthermore, public companies must prepare their balance sheets in accordance with GAAP. Public balance sheets must also be filed with the SEC on a regular basis.
There are no predefined or standardized subcategory groupings. In contrast, your financial management team can determine which classifications are appropriate for your short- and long-term objectives.