“It sounds extraordinary, but it’s a fact that balance sheets can make fascinating reading.” (Mary Archer)
A balance sheet reveals a company’s “book value” by showing what assets it owns, what liabilities it owes, and the equity or net worth attributable to its owners, at a specific point in time.
Because all resources or assets are either funded by borrowing (liabilities) or owner investments (equity), the fundamental accounting equation that underpins the balance sheet is:
Assets = Liabilities + Equity.
Key components of a balance sheet
- Assets are resources controlled by a company that is expected to generate future value. These include current assets, such as cash, accounts receivable, and inventory; and non-current or long-term assets such as property, equipment, trademarks, and patents.
- Liabilities are obligations the company owes to external parties. These include current liabilities, such as accounts payable, payroll and short-term loans, and non-current or long-term liabilities like bonds, leases and deferred tax liabilities.
- Owners’ equity represents the net worth of a company after liabilities are deducted from assets and includes retained earnings and contributed capital, among others.
What your balance sheet says about your business
The balance sheet is an important tool for evaluating your company’s financial health and operational efficiency.
By providing an overview of the assets and liabilities of the company and how they relate to each other, the balance sheet can help answer questions such as whether your company has a positive net worth, whether it has enough cash and short-term assets to cover its obligations, and how indebted it is compared to its peers.
The balance sheet will show when a company is borrowing too much money, if the assets it owns are not liquid enough, or if it has enough cash on hand to meet current liabilities.
For this reason, balance sheets are also used to secure capital, private equity funding, business loans or bank finance, as they allow stakeholders to assess the financial health of a company, its solvency, and its ability to repay short-term debts…