Understanding Balance Sheet
A balance sheet is one of the major financial statements of the company which showcases the company’s total assets as well as how they are financed, through debt or equity. Hence, the simple fundamental equation of the balance sheet is:
Assets = Liabilities + Equity
Components of balance sheet
The asset comprises current assets as well as non-current assets. Current assets are those assets that are expected to liquidate within a year while non-current assets take more than a year. Examples of current assets are cash, accounts receivables, inventory, pre-paid liabilities while non-current assets include buildings, plant & machinery, etc.
On another side of the balance sheet, we have liabilities and shareholder’s equity. Shareholders’ equity represents the number of funds invested by the owners in the business. Liabilities are again further divided into current liabilities as well as non-current liabilities.
Some of the examples of current liabilities include accounts payables, short-term loans, trade payables while noncurrent liabilities include debentures, loans, bonds, etc.
Importance of balance sheet
- A balance sheet is used to analyse a company’s financial position.
- A lot of financial ratios are derived from the data given in the balance sheet alone to examine the financial health of a company.
For instance, we get to know the liquidity of the company by deriving the current ratio and quick ratio. We find other financial metrics like leveraging, efficiency, rates of return by deriving ratios like Debt to Equity, Asset Turnover Ratio and Return on Equity respectively.