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How to Read a Balance Sheet

Summary: How to interpret your Balance Sheet and figure out what your business is really worth. Plus get a free 30 minute analysis of your Balance Sheet on Skype by our experts.

How 2 INTERPRET your FINANCIALS – (1 OF 3) THE BALANCE SHEET

Whether you are an investor or running your own business you need to understand your financial statements, they are the keys to the company!

They can warn of potential problems, and when used correctly, help determine what a business is really “worth”.

In this three part series, we will show you that anyone can learn how to read the BIG THREE: The Balance Sheet, the Income Statement, and the Cash Flow Statement.

A balance sheet is always prepared at the close of business on the last day of the period, i.e. at a single point in time.

The balance sheet should always be in sync with the income statement.

Assets are what a company uses to run its business, and its liabilities and equity are two sources that support these assets.

Owners’ equity, referred to as shareholders’ equity in a publicly traded company, is the amount of money initially invested into the company plus any retained earnings/profit.

Click Here to get a FREE 30 minute Balance Sheet Analysis by our Experts

Step 1: A = L + OE

The balance sheet is divided into two parts that must balance according to the accounting equation.

The total ASSETS of the business must equal the sum of the LIABILITIES plus the OWNERS EQUITY.

Balance Sheets are generally set up with the ASSETS on the left side and the LIABILITIES and EQUITY on the right.

Step 2: ASSETS

  1. Current Assets
    1. Current assets are defined as having a life span of less than one year. Current assets may include cash / cash equivalents, accounts receivable and inventory. Cash, the most fundamental of current assets, also includes non-restricted bank accounts and cheques. Cash equivalents are very assets that can be readily converted into cash, e.g. Forex. Accounts receivables consist of the payments due to the company by its clients. Depending on the type of business, inventory would represent the raw materials, work-in-progress or the company’s finished goods.
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  1. Non-Current Assets
    • Non-current assets are assets that are not turned into cash easily and have a lifespan of more than a year. They can refer to fixed assets such as machinery, computers, buildings and land. Non-current assets also can be intangible assets, such as goodwill (the established reputation of a business regarded as a quantifiable asset, e.g., as represented by the excess of the price paid at a takeover for a company over its fair market value), patents or copyright. While these assets are not physical in nature, or easy to quantify, they often make or break a company – the value of a brand name, for instance, should not be underestimated. Always treat these values however cautiously and have their values checked by an independent third party, or at very least ask for the workings used to quantify their values.
  1. Accumulated Depreciation is calculated and deducted from most of these assets annually, or more often depending on the accounting practises. It can be defined as a reduction in the value of the asset with the passage of time, due in particular to wear and tear. Depreciation” is used for physical property, like cars, and “amortisation” for nonphysical assets like goodwill.

Step 3: LIABILITIES

On the other side of the balance sheet are the liabilities. These are the financial obligation owed by the company to other entities. As with assets, they can be either current or long-term.

  1. Long-term liabilities are debts and other obligations, which are due after more than a year from the date of the balance sheet.
  1. Current liabilities are the company’s liabilities that will come due, or must be paid, within the year. This includes both shorter-term borrowings, such as accounts payables, along with the current portion of longer-term borrowing, such as the latest interest payment on a 10-year loan.

Step 4: OWNERS EQUITY

Shareholders’ equity is made up of the initial amount of money invested into a business. If, at the end of the financial year, a company decides to reinvest its profit into the company, these retained earnings will be transferred from the income statement onto the balance sheet and into the shareholder’s equity account.

Any funds taken out of the business by the owners are also deducted, as drawings.

Step 5: ANALYSE WITH RATIOS

Although all of the information you need to see, appears in the Financial Statements, you would need to use some techniques to analyse the information. There are infinite ways to do this.

Financial strength and liquidity ratios, which are the most relevant, provide information on how well the company can meet its obligations and how the obligations can be leveraged.

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Click Here to get a FREE 30 minute Balance Sheet Analysis by our Experts

 

About The Author

Keri Garland

Keri Garland is a successful businesswoman and owns an Outsourced Staffing Company called Office Execs. Her specialist team will do your office tasks, payroll, accounting, secretarial services and HR management, so you can focus on your core business. Packages suitable for SME's. www.officeexecs.co.za