As a shareholder or a potential company investor, it is essential to know how a balance sheet works, and how it is organized, analyzed, and read.
To read your balance sheet, you need to evaluate your company’s assets, liabilities, and equity to better view what your company holds and owns at any time.
Whether you’re an entrepreneur, worker, or investor, understanding all the data on a balance sheet and how to read it is fundamental knowledge.
Balance sheet
A Balance sheet discloses the company’s assets, liabilities, and equity. A balance sheet is one of the statements that the company prepares in addition to other statements.
A balance sheet is a financial document comprising the assets, total debt, liabilities, and equity capital of a specific date. It is structured to express the actual worth of a company.
Balance sheets can be prepared monthly, quarterly, or annually based on the company agreement. Assets are usually on one side of the balance sheet, and liabilities are on the other.
How does a Balance Sheet Work
The balance sheet is more similar to a preview of an organization’s financial situation at a predetermined time, generally calculated after each quarter, a half year, or one year. Balance sheets have two fundamental heads, known as assets and liabilities.
#1. Assets
Assets are the things or materials that the organization possesses. They can be separated into current or non-current.
Assets are equivalent to total liabilities, shareholder, or owner’s equity. Shareholders equity is used when a publicly traded company or corporation, and owners equity is for a sole proprietorship.
Access is anything of significance worth your business control. Money, office hardware (PCs, seats, etc.), and stock are viewed as assets.
So are debt claims, which address individuals who owe you cash but haven’t yet paid. Any resource a company possesses is known as an asset.
Asset reports are divided into business assets (debits) and a business’s financial obligation, known as credits. A balance sheet must always balance, but if it doesn’t, it is not prepared correctly.
#2. Liabilities
Liabilities are commitments or debts of an organization. The sum the organization owes to its lenders. Liabilities can be separated into current liabilities and non-liabilities or long-term liabilities.
Liabilities are due you owe to others. This could be to your suppliers or a credit card balance. Any obligations or future financial commitments you need to pay should be recorded in the liabilities segment.
Assets are what a company possesses. Liability is what it owes. Liabilities are monetary and legitimate obligations to pay a measure of cash to a debtor, which is why they’re generally counted as negatives (- ) in a balance sheet.
#3. Owner’s Equity
Owners equity addresses the segment of the business resources you own for free.
The balance sheet must balance each other
The formula is
Assets = Liabilities + Shareholder’s Equity
This implies that assets are a balanced financial commitment of the company, alongside the owner’s equity and retained earnings.
A company uses assets to operate its business, and the two sources that help these assets are liabilities and equity.
Shareholders equity for publicly traded companies is the initial investment made to a company and the retained earnings.
9 Tips to Read a Company Balance Sheet.
#1. You need to Understand all the things the company owns
You need to find out the total assets the company owns. Assets, in this case, include machinery, buildings, vehicles, cash, and even securities.
#2. Understand the date and time of the company balance sheet
A balance sheet portrays an organization’s total assets, liabilities, and owner’s equity on a particular date. The date is usually the last day it will be reported, referred to as reporting time.
Some companies will report the balance sheet quarterly or annually. You need to understand the date and the time the balance sheet was reported.
#3. Understand Current Assets
Current assets are significant worth owned by your company that will be changed over into cash within one year. Current assets include:
Cash: this includes hard currency, checks, and others.
Inventory: this is the company that sells physical products, which include raw materials, processing products, and finished products.
Accounts receivable: these are the company’s short-term payments.
#4. Understand Non-Current Assets
Non-current assets are the ones that can’t be changed over to cash effectively and will not be changed over within one year. Tangible and intangible are part of the non-current assets.
#5. Understand current liabilities
Current liabilities are any obligations due to a party within one year.
#6. Understand Non- Current Liabilities
Non-current refers to obligations due to a party for 12 months or more. It also provides goods and services for future purposes or use.
#7. Understand Retained Earnings
The amount of profit an organization procured for a specific time frame is referred to as Retained Earnings. The retained earnings statement is the financial assertion that reports the company’s profit or net income after the shareholders are paid their dividends.
This income can be kept and reinvested in the company’s business.
The Retained Earnings are documented under the shareholder’s equity segment of the balance sheet at the end of each accounting period.
To calculate the retained earnings, you need to add the previous terms’ retained earnings (quarterly or annually) and the net income and deduct the cash dividend and the stock dividend.
This is how to calculate the retained earnings.
Retained Earnings = Previous year’s retained earnings + Net Income – Cash Dividend – Stock Dividends.
#8 Understand Shareholder’s Equity
A company’s total net worth is referred to as shareholders’ equity. It incorporates the initial amount of cash the owner invests in the business.
Suppose a company reinvests its net profit into the business at the end of every quarter or year. The remaining profits or earnings are reported on shareholder equity of the balance sheet.
#9. Add Total Liabilities to Total Shareholders’ Equity and Compare to Assets
To guarantee that the Balance Sheet has been balanced, you will need to analyze its total assets against its total liabilities and equity. To do this, you will add the shareholder’s equity and the liabilities into a single unit.
Summary
A balance sheet is essential for potential investors and shareholders to get a clear view of its activities. The balance sheet aims to offer potential investors an idea of the company’s financial situation and show what the company holds and owns.
It is expedient that all investors must understand how to analyze, use and read a balance sheet.
It may be challenging to tell if a company is doing well or struggling without knowing the balance sheet. Understanding and learning how to read it is essential for interested investors.
