How To Read Balance Sheet: Understanding With Example

Financial statements provide an overview of a business's financial health. A financial statement could be a Balance Sheet, Income Statement, or Cash Flow Statement. The Balance Sheet, in particular, offers a detailed view of a company's assets, liabilities, and equity at a specific point in time, making it essential to understand the financial position. In this article, we will highlight how to understand a balance sheet.

What is the Balance Sheet?

The Balance Sheet is a financial statement that reflects a company's financial state at a certain point in time. It indicates what a company owns (assets), what it owes (liabilities), and the owner's equity, which is the amount that remains in the assets after deducting liabilities. The balance sheet follows the accounting equation: Assets = Liabilities + Equity.

Balance Sheet Items

The balance sheet items are typically categorized into three main sections: Assets, Liabilities, and Equity.

Assets

Resources owned by the company. They are divided into:

Current Assets: Assets that are expected to be converted to cash or consumed within a year. They include:

• Cash and Cash Equivalents: The most liquid form of assets, including money in bank accounts or short-term investments.
• Accounts Receivable: Accounts Receivable are amounts that clients owe to a company for goods or services delivered.
• Inventory: Goods or materials a company holds for sale in the ordinary course of business.

Non-Current Assets: These are long-term assets that a company expects to hold for more than one year. They include:

• Property, Plant, and Equipment (PP&E): Physical assets like buildings, machinery, and land.
• Intangible Assets: Non-physical assets like licenses, copyrights, or goodwill.

Liabilities

Obligations the company owes. They are split into:

Current Liabilities: Responsibilities that the company must fulfill within a year. They include:

• Accounts Payable: Amounts that a company owes to suppliers for received services or goods.
• Short-Term Debt: Loans or financial obligations due within a year, including portions of long-term loans that are due in the short term.

Non-Current Liabilities: Long-term obligations that are due after one year. They include:

• Long-Term Debt: Loans or bonds that the company must repay over a period longer than one year.
• Deferred Tax Liabilities: Taxes owed that will be paid in the future due to timing differences between accounting and tax practices.

Equity

Equity is the residual value of assets after all liabilities are settled, showing the net worth of the company.

Owner's Equity: This represents the shareholders' ownership interest in the company. It includes:

• Common Stock: Shares provided to investors value.
• Retained Earnings: Profits that the company has earned and retained, rather than distributing them as dividends.

How To Read a Balance Sheet?

To effectively read a balance sheet, you need to understand the three primary sections: assets, liabilities, and equity. Each section provides insights into the company’s financial state.

Balance Sheet Example

Current Assets

• Cash ($5,000): This shows how much cash the company has readily available.
• Accounts Receivable ($7,000): This amount reflects money owed by customers for products or services that have been delivered but not yet paid for.
• Inventory ($8,000): Represents the value of goods the company has in stock that are available for sale.

Total Current Assets ($20,000): These assets are expected to be converted into cash within a year. High current assets relative to current liabilities indicate good short-term financial health.

Non-Current Assets

• Property, Plant & Equipment ($50,000): These are the company’s long-term physical assets, like buildings or machinery.
• Intangible Assets ($10,000): These include non-physical assets such as patents or trademarks.

Total Non-Current Assets ($60,000): These are assets the company expects to hold for longer than one year, typically used to support the business over the long term.

Current Liabilities

• Accounts Payable ($2,500): This is the money the company owes to suppliers for goods or services already received.
• Short-term Loan ($3,000): A debt that must be paid within one year.

Total Current Liabilities ($5,500): These are short-term financial obligations the company needs to settle within a year.

Non-Current Liabilities

Long-term Loan ($15,000): A loan that is due after one year.

Total Non-Current Liabilities ($15,000): These are the company's long-term obligations.

Equity

• Common Stock ($30,000): The value of the company’s shares issued to investors.
• Retained Earnings ($29,500): Profits the company has earned and retained for growth or debt repayment.

Total Equity ($59,500): This represents the owners' stake in the company after liabilities are deducted from assets.

To read a balance sheet, compare assets with liabilities and equity. In this example:

- The company has $80,000 in total assets and $20,500 in total liabilities.

- After settling its liabilities, the company’s equity is $59,500.

This balance sheet shows a strong financial position since the company's assets significantly exceed its liabilities, and it holds a healthy level of equity.

What Does a Balance Sheet Tell You?

A balance sheet reflects a company’s financial health, showing its liquidity, debt levels, and growth. It assesses the company's ability to meet short-term obligations, manage debt, and invest in long-term assets, providing a complete overview of financial stability and efficiency.

1. Financial Health: A balance sheet provides valuable insights into a company’s financial position. The balance sheet reflects what a company owns (assets) and owes (liabilities) at a specific period, showing how financially stable the business is.
2. Leverage: The balance sheet shows how much of the company’s assets are financed through liabilities versus equity. A high proportion of liabilities might indicate that the company relies heavily on debts, which might be risky.
3. Liquidity: Comparing current assets with current liabilities assesses a company's ability to meet short-term obligations. A higher level of current assets compared to current liabilities indicates good liquidity.
4. Operational Efficiency: It evaluates how efficiently a business uses its assets. For example, a high inventory or receivables ratio in comparison to sales can indicate inefficiency.
5. Owner's Equity: The balance sheet shows how much of the business belongs to its owners after all liabilities are paid. A growing equity base indicates that the company is retaining profits and growing over time.

FAQ

How to read a company balance sheet?

Assets: This company has total assets worth $60,000. This includes $23,000 in current assets, which can be easily converted to cash, and $37,000 in non-current assets, representing long-term investments like property and intangible assets.

Liabilities: The company owes a total of $25,000. This consists of $10,000 in current liabilities, due within a year, and $15,000 in long-term debt.

Current assets ($23,000) are more than current liabilities ($10,000), indicating the company has sufficient liquidity to cover short-term obligations.

Equity: The equity section shows that the shareholders have invested $10,000 in common stock, and the company has retained $25,000 in earnings.

Total equity is $35,000, indicating that a large portion of the company's resources comes from the owners rather than debt.

This balance sheet reflects a company that is funded by both equity and some debt but seems to maintain healthy liquidity and moderate levels of long-term debt.

How to read a nonprofit balance sheet?

To read a nonprofit balance sheet, focus on three key sections:

• Assets: What the organization owns, including current (cash, receivables) and non-current assets (property, investments).
• Liabilities: What the nonprofit owes, split into current (short-term debts) and non-current (long-term obligations).
• Net Assets: Equivalent to equity, divided into unrestricted (general use), temporarily restricted, and permanently restricted.

Ensure that assets balance with liabilities and net assets, and pay attention to how restricted funds are managed.

How to read a bank balance sheet?

Reading a bank balance sheet requires focusing on the following aspects:

• Assets: Primarily loans (to customers) and investments. Includes cash reserves and securities the bank holds.
• Liabilities: Customer deposits (savings, checking accounts) and borrowings from other banks or financial institutions.
• Equity: The bank's net worth, including retained earnings and capital from shareholders.

Key metrics to watch

• Loan-to-Deposit Ratio: This shows how much of the bank's deposits are loaned out.
• Capital Adequacy: Measures the bank's financial stability and risk levels.

Streamlining Balance Sheet With Enerpize

Enerpize's online accounting software simplifies generating and managing balance sheets by automating them and providing real-time insights. With user-friendly dashboards, you can easily track assets, liabilities, and net assets, ensuring accuracy and compliance.

Streamlining financial reporting not only saves time but also enhances decision-making, allowing your organization to focus on its mission and growth. Optimize your financial management today with Enerpize’s comprehensive tools developed for efficiency and clarity.