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Often, companies focus on their income statement and statement of cash flows without giving much thought to the balance sheet. This is a mistake! The balance sheet is important because:

– Shows the effect of past decisions.
– Tracks the liquidity of a company’s cash position
– Records what is the Owner’s Equity position in different time intervals
– Directly affected by the Cash Flow and Income Statements, which reflect the state of the company’s operation
– Quickly shows the condition of a business

The balance sheet illustrates how a company’s assets, liabilities, and net worth are distributed at a given point in time or period of time. The format of the set of Balances facilitates the analysis. The order of the categories broken down on the Balance Sheet is arranged in the Decreasing order of Liquidity and Immediacy for Assets and Liabilities respectively. Because the Balance Sheet shows changes in the Company’s Debt, Equity, and condition over time, it is an excellent monitoring and control document. Before we get into balance sheet analysis, let’s examine the important sections of the balance sheet (see Balance Sheet Example (Simple Format) at the end of this article).

– Current Assets: Cash, Government and Negotiable Securities, Notes Receivable, Accounts Receivable, Inventories and Prepaid Expenses. Any other item that can be converted to cash within a year.

– Fixed Assets: Land, Plants, Equipment, Improvements to Leased Premises. Other items that are expected to have a commercial useful life that can be measured in years.
— Depreciation applied to items that wear out.

– Other Assets: Intangibles such as Copyrights, Patents, Exclusivity of Contracts and Notes Receivable from Company Employees and Officials.

– Current Liabilities: Accounts and Documents Payable; Expenses that Accrue (such as Wages, Salaries, Withholdings, FICA); Tax to Pay; Current part of the Long-Term Debt; and other Obligations due within one year.

– Long-Term Liabilities: Deeds of Trust, Mortgages, Equipment Loans and Long-Term Bank Loans. All of these are net of the current part of the Long-Term Debt (appears as Current Liabilities).

– Net Worth: Assets minus Liabilities.

– Owners’ equity: shareholding of directors, retained earnings and other equity.

balance sheet analysis

Three ways to quickly determine the health of your business:

1) Analyze working capital: Subtract current liabilities from current assets to determine your level of working capital. Cash is only one part of working capital.
a) Illiquid companies may have difficulty obtaining future loans. The solutions are working capital loans, sale of fixed assets, financing of accounts payable or securing new capital investments.

2) Compare Fixed Period Balance Sheets – By comparing similar time periods, you can quickly spot trends and weak areas, which upon investigation can determine the reasons behind them. If you’re an established company, compare year-end balance sheets. If you are a new company, compare Balance Sheets from one quarter to the next. After analysis, problem areas and strong areas jump right off the page!

3) Current and Acid Test Ratios – These analyzes are based on percentages versus dollars, so it’s easy to compare them to industry and area norms from similar companies.
a) Current Ratio: Measures the Liquidity of a Company or its ability to meet current obligations in the coming year.

Yo. Formula: Current Assets ÷ Current Liabilities
ii. For the analysis to mean anything, it is important to understand what this ratio represents. Factors that affect the current relationship are the type of inventory, the quality of accounts receivable, the timing of the sales cycle, the time of year, etc. A ratio of 2.0 generally represents a healthy company, but it really depends on the type of company and the industry.

b) Acid Test: The “Quick Ratio” is calculated by dividing the Most Liquid Assets of a Company by the Current Liabilities. Liquid Assets include Cash, Securities and Current Accounts Receivable. A ratio of 1.0 generally represents a healthy company, but is company and industry specific.

Note: Benchmarks of 2.0 current ratio and 1.0 acid test (fast ratio) are not industry specific. Be sure to research healthy levels for companies that are very similar to yours. Trade associations, banks, and Dun & Bradstreet are good sources of comparative ratio information.

Footnotes: Footnotes to assumptions and calculations are very important to an external reader, such as a banker. A bank would be interested in knowing how restricted its Assets are, so an explanation would be necessary for each Asset item. An investor would be very interested in the details of Owner’s Equity. A banker would also be interested in a breakdown of accounts payable, detailing exactly when the liabilities are due.

Example of balance sheet (simple format)

Assets
Current assets
Fixed assets

• (Less) Accumulated Depreciation
• Net fixed assets

Other assets
total assets
Passive
current liabilities
Long term passives
Full responsibility
NET Value / Owners Equity
Total liabilities and net worth