The blog will be a great guide for you to understand what Is Balance Sheet in accounting and other important aspects of Balance Sheet including what is structure of Balance Sheet, how it is used in financial modelling, the importance of balance sheet.
The balance sheet is a financial statement, and it displays the company’s total assets and how the assets are financed. The balance sheet has three parts: Equity, which only includes things like earnings and property; Liabilities, which describes debts that the business has owed; and Assets, which makes up all of the company’s material wealth.
To calculate the net worth of a company, you need to understand what each side of the balance sheet begins with. Assets on the left, and liabilities plus shareholders’ equity on the right.
The current section contains more liquid assets, with less liquid assets in the non-current section. For example, current account balances include Inventory and Cash, while PP&E and Long-Term Debt (Non-Current) would be in the non-current section.
What is The Structure Of Balance Sheet?
Understanding structure of Balance Sheet is one of the important aspects of knowing what is Balance Sheet in accounting. Generally speaking, in every balance sheet there is a section for current assets and another for long-term assets. There are three common items under short-term assets, which are cash, accounts receivable and inventory. The two common items under long-term assets include property and equipment, as well as goodwill.
Current Assets
Accounts Receivable
The accounts receivable account includes the balance of all sales revenue still on credit, net of any allowances for doubtful accounts. As companies recover unpaid accounts, this account decreases, and cash increases by the same amount.
Inventory
The inventory account contains levels of raw materials, work-in-progress goods, and finished goods. When you report sales of goods and general cost of goods sold in the income statement, you use this account.
Cash and Equivalents
Cash is the most liquid of all assets. This first appears on the balance sheet, and also contains cash equivalents with short-term maturities or liquidable securities, which will be noted in the footnotes.
Non – Current Assets
Intangible Assets
This line item includes all intangible fixed assets, which may not be identifiable by the company. The identifiable intangible assets include patents, licenses and secret formulas. Unidentifiable intangible assets include brand and goodwill.
Plant, Property, and Equipment (PP&E)
Some companies will list the property, plant, and equipment of their company by separating them into types such as land, buildings, and machinery. All PP&E is appreciable except for land.
Current Liabilities
Current Debt/Notes Payable
Notes payable include any obligations due within one year’s time or within one operating cycle for the company. Notes payable may also have short-term and long-term versions, which includes notes with a maturity of a single year and those with more than one year.
Accounts Payable
Accounts Payables is the money a company owes suppliers for items or services purchased on credit. As the company pays off its AP, it decreases along with an equal decrease to their cash account.
Current Portion of Long-Term Debt
Long-term debt is any debt that will take over one year to pay off. The current portion of long-term debt is the part that’s due this year.
Non-Current Liabilities
Long-Term Debt
The company uses the debt schedule, which categorizes all the company’s outstanding debt.
Bonds Payable
This account includes the amortized amount of any bonds the company has issued.
Shareholders’ Equity
A company’s equity is equivalent to its total assets minus its liability. These are also known as net assets.
How the Balance Sheet is used in Financial Modeling
Now that you have fair idea on what is Balance Sheet in accouting & what is its structure, let’s find out how balance sheet is used in Financial Modeling.
This statement is a great way to show a company’s financial position. A balance sheet can be used to calculate several key financial ratios that provide insight into how well a company is performing, its liquidity and solvency, and its efficiency.
When calculating the cash in a cash flow statement, it is important to take into account changes that may occur in the balance sheet. Examples of this include acquisitions less payments for property and equipment, as indicated by a change in the plant, property and equipment account. By considering depreciation expense, capital expenditure can be determined and included as a cash outflow under investing.
Why Is a Balance Sheet Important?
There are many benefits of a balance sheet, such as guaranteeing the ability to prove financial stability.
The balance sheet is perfect for assessing risk. Essentially, it lists everything your company owns and all of its debt. Using this financial statement, companies can quickly assess whether they have borrowed too much money, whether the assets they own are not liquid enough, or whether they have enough cash on hand to meet current demands.
Balance sheets are used when a company needs to secure capital. To get a business loan, they sometimes must provide a balance sheet to prove their financial health. For private equity, they need to present the balance sheet of their company so the investor can assess the creditworthiness of the company.
Managers can use financial ratios to measure liquidity, profitability, solvency and cadence to better understand the health of a company. Financial ratios are taken from the balance sheet for companies that meet certain standards.
Balance sheets allow companies to attract and retain talented employees. They usually prefer knowing their jobs are secured and that their company is in good health financially. Public companies that have to disclose their balance sheets give employees the opportunity to review how much cash the company has on hand, how smart it is managing debt, and how much they trust the company’s financial stability based on their own expectations.
Understand four important financial performance metrics:
1. Liquidity – A company’s liquidity is determined by comparing current assets to current liabilities and determining that asset should be greater than the liabilities. The Current Ratio and Quick Ratio are a couple financial terms which explore this.
2. Leverage – If you look at a company’s financing, it will indicate to you how much leverage that company has. This in turn indicates how much financial risk the company is taking. Then if you compare debt to equity ratio and debt to total capital, these are both common ways of assessing leverage on the balance sheet.
3. Efficiency – The revenue divided by the average total assets tells the Asset Turnover Ratio, gauging how efficiently the company turns their assets into revenue. Likewise, the working capital cycle shows how well a company manages cash in a short term period.
4. Rates of Return – There are 3 rates of return you can determine by examining a company’s balance sheet. The first is Return on Equity, which calculates shareholders’ equity as a percentage of net income. Second is ROA, the percentage of net income from total assets. Third is ROIC; it calculates net income from debt and shareholder equity.
Who Prepares the Balance Sheet?
Preparation of balance sheets differs depending on the company. For example, with small privately-held businesses, the balance sheet is prepared by the owner or a company bookkeeper. With mid-size private firms, they may be prepared internally and then looked over by an external accountant.
Public companies must comply with the strict standards of an external audit by public accountants to be considered a reliable source for the public.
Real Life Example: Balance Sheet Of Tata Motors
