Overview and Definition
The balance sheet is one of the financial statements required of all public companies for their quarterly and annual statements. Even a privately held small business should prepare year-end financial statements for review by executives, management, and private investors. Each SEC filing must include the following financial statements: balance sheet, income statement, and cash flow statement. It's provided along with the cash flow statement and the income statement to allow investors and other stakeholders a means for analyzing the company's overall health. The balance sheet provides a look at the company's net value and financial position in terms of the company's assets, total liabilities, and even projected earnings. When evaluated along with the other financial statements, a balance sheet provides a view of the company at a specific point in time. The income statement, balance sheet, and cash flow statement offer financial analysts a clear snapshot of a company's financial position at a specific point in time from which to project future shareholders equity. After all, no firm maintains financial health without a clear accounting of the books.
One can think of the balance sheet in terms of this equation:
Assets = Liabilities + Equity
The balance sheet provides shareholders a view of the company at a specific point in time, including assets, liabilities, and material events at the end of a fiscal period. Frequently, figures from previous periods are displayed along with the current numbers as as way to account for fluctuations in shareholders equity. This way, investors can measure the company's assets, relative growth, and overall valuation. Furthermore, shareholders use a balance sheet as a tool for measuring liabilities and shareholders' equity. When analysts assess all of the financial statements they can arrive at a sound assessment of the company and its place in the market.
What Does the Balance Sheet Cover?
On the balance sheet, assets are a chief part. The company's current assets are comprised of the total cash on hand, equipment, property, inventories, and securities. The sheet is organized to reflect the ease with which each line item can be converted to cash. They are of two general types of assets: current assets which can be liquidated in under a year and non-current/long-term assets which will take longer to liquidate into cash.
Liabilities include all funds that are owed to third parties as short or long term debt. These debits are recorded on a company's balance sheet. Taxation is a type of liability, as is a line of credit. Like investments, these debts are considered either long-term liabilities or short-term. A short-term liability should be paid off within a year and long-term debts are due to be paid at any point after a year. A small bridge loan might be considered a short-term liability while a mortgage is listed with the long-term debits.
The liabilities and shareholder’s equity in any company are balanced and calculated as part of the net assets or net worth of a company, which is helpful in calculating the company's overall net value and financial position. Once the total assets are calculated and then all the liabilities deducted, the remaining assets comprise the total value held by the shareholders. Another way to think of net worth is that it is what remains after a company pays off all its liabilities.
What’s It Used For?
The balance sheet is used to show the present-day worth of a company including the total assets and current liabilities. The current period's balance sheet might demonstrate great value or dangerous debt, but a balance sheet's true value comes when investors compare a company's balance sheets over time. It might be interesting to review the balance sheets from multiple years, but the company's financial story is even further developed when one reviews the most current quarterly statement of financial position, as well. This can help investors make investments at the most opportune moments. For example, if a company's overall worth declines at the same point each year, due to seasonal shifts, that might be the best time to invest.
Taken by itself, the balance sheet demonstrates the company's financial position, including its current liquidity and current liabilities. The balance sheet is also used on conjunction with the income statement to determine a company's efficiency, and what the statement reveals helps investors determine how well the entity is leveraged. The sheet also enables analysts to calculate return on equity, return on assets, and return on invested capital. Though reducing liabilities and shareholders' equity is a top priority, the balance sheet should be solidly in the black every quarter.
The balance sheet is inherently limited by the fact that it only offers a snapshot in time and says very little about the company itself. The balance sheet only shows a company's total worth at a specific period in time. It does not address pertinent financial details such as the company's income or its cash flow. Other statements must be used alongside the balance sheet to provide more depth in terms of how the company manages its assets and liabilities, which the balance sheet only quantifies as static elements.
However, it is possible to compare year-over-year balance sheets as a way to seek trends or patterns. In fact, financial analysts will pull the balance sheet, along with the other required financial statements, from each SEC filing a company has made for the previous three years or so. Sometimes, the quarterly balance sheet provides more detail, but the balance sheet and other annual financial statements are often sufficient. More depth might be reached when one includes quarterly statements and examines other filings, as well. However, it cannot be used in exclusion of the other financial statements if one is seeking a comprehensive picture of a corporation.