What Is Importance Of A Balance Sheet And Its Limitations?
No matter the size of the company or the industry in which it operates, the balance sheet has many advantages,
Balance sheets identify risk. This financial statement lists the company’s assets and all of its debts. The company will quickly be able to assess whether it has borrowed too much, whether its assets are not liquid enough, or whether it has enough cash to meet current demands.
Balance sheets are also used to secure capital. In order to obtain a business loan, the company is usually required to provide the lender with a balance sheet. A company is usually required to provide a balance sheet to private investors when seeking to secure private equity financing. In either case, the outside party wants to assess the company’s financial condition, its business reputation, and whether the company will be able to pay its short-term debts.
Managers can choose financial ratios to measure a company’s liquidity, profitability, solvency, and cadence (turnover rate) using financial ratios, and some financial ratios require numbers taken from the balance sheet. When analyzed over time or compared to competing companies, managers can better understand ways to improve a company’s financial health.
Finally, the balance sheet can attract and retain talent. Employees generally want to know that their jobs are secure and that the company they work for is healthy. For public companies that have to disclose their balance sheets, this requirement gives employees an opportunity to assess how much cash the company has, whether the company is making smart decisions when managing debt, and feel that the company’s financial condition is in line with it. What do they expect from the employer?
Balance Sheet Limits
Although the balance sheet is an invaluable piece of information for investors and analysts, it has some drawbacks. Because they are static, many financial ratios are developed on the data included in both the balance sheet and the more dynamic income statement and cash flow statement to paint a complete picture of what is happening in the company’s business. For this reason, the balance sheet alone cannot paint a complete picture of a company’s financial health.
The balance sheet is limited by time constraints. The financial statement only captures the company’s financial position on a particular day. It can be difficult to determine if a company is doing well by looking at the balance sheet itself. For example, imagine a company has $1,000,000 in cash at the end of the month. Without context, a point of comparison, knowledge of past cash balances, an understanding of industry operating requirements, and knowledge of how much cash a company has is of limited value.
Different accounting systems and ways of dealing with depreciation and inventory will also change the numbers published on the balance sheet. Pay attention to the footnotes to the balance sheet to identify the accounting systems they use and look for red flags.
Finally, the balance sheet is subject to many areas of professional judgment that may materially affect the report. For example, receivables must be continually assessed for impairment and adjusted to reflect possible uncollectible accounts. Without knowing what receivables the company is likely to actually receive, the company must make estimates and reflect its best estimate as part of the balance sheet.
Example Of A Balance Sheet
The figure below is an example of a comparative balance sheet for Apple, Inc. This balance sheet compares the company’s financial position as of September 2020 with the company’s financial position from the previous year.
In this example, Apple’s total assets of $323.8 billion are separated at the top of the report. This asset segment is divided into current assets and non-current assets, and each of these categories is divided into specific accounts. A brief review of Apple’s assets shows that their money has decreased, yet their non-current assets have increased.
This balance sheet also includes reports on Apple’s liabilities and shareholder equity, with each section at the bottom of the report. The liabilities section is divided like the assets section, with current liabilities and non-current liabilities reporting account balances separately. The total shareholder’s equity section shows the value of common stock, retained earnings, and accumulated other comprehensive income. Apple’s total liabilities increased, total equity decreased, and the combination of the two increased the company’s total assets.
Why Is The Balance Sheet Important?
The balance sheet is a important tool for executives, investors, analysts, and regulators to evaluate a business’ financial financial situation. It is most commonly used with two other types of financial statements: the income statement and the cash flow statement.
Balance sheets allow the user to see a company’s assets and liabilities at a glance. A balance sheet can help users answer questions such as whether a company’s net worth is positive, whether it has enough cash and short-term assets to cover its liabilities, and whether the company is in line with its peers.
What Is Included In The Balance Sheet?
Depending on the company, this may include short-term assets, such as cash and accounts receivable, or long-term assets such as property, plant and equipment (PP&E).
Who Prepares The Balance Sheet?
For small, private companies, the balance sheet may be prepared by the owner or the company’s accountant. For medium-sized private companies, it may be set up internally and then maintained by an outside accountant.
On the other hand, public companies are required to obtain external audits from public accountants, as well as ensure that their books are kept to a very high standard. The balance sheets and other financial statements of these companies must be prepared in accordance with Generally Accepted Accounting Principles (GAAP) and submitted regularly to the Securities and Exchange Commission (SEC).
What Are The Uses Of The Balance Sheet?
Unlike an income statement, which reports financial information over a period of time, a balance sheet is used to determine a company’s health on a given day.
The bank statement is often used by parties outside the company to assess the health of the company. Banks, lenders, and other institutions can calculate financial ratios from balance sheet balances to gauge how risky a company is, how liquid its assets are, and how likely it is that the company will remain solvent.
A company can use its balance sheet to make internal decisions, although the information provided is usually not as informative as an income statement. A company can look at its balance sheet to gauge risk, make sure it has enough cash, and figure out how it wants to raise more capital (debt or through equity).
What Is The Balance Sheet Format?
The balance sheet is calculated by balancing a company’s assets with its liabilities and equity. The formula is: Total Assets = Total Liabilities + Total Equity.
Total assets are calculated as the sum of all short-term, long-term and other assets. Total liabilities are calculated as the sum of all short-term, long-term and other liabilities. Total equity is calculated as net income, retained earnings, owner contributions, and share of shares issued.