The balance sheet is one of the well-known financial statements of a company. It is designed to show everything a business owns and everything a business owes in one quick look. While other statements like the income statement or statement of cash flows are more traditionally used to examine company revenues and profit ratios, the balance sheet also can play an important role in judging company worth. Experienced investors and analysts always include it in their calculations.
Balance Sheet Composition
The balance sheet is made of two different parts: business assets and everything else. The assets are everything the business owns, including its inventory, any money in the bank, and intangibles like copyrights. On the other side are all the liabilities the company has, including both long- and short-term debts. Added to these liabilities is all the equity the business has, which is the money that has been invested into the company. The assets should always equal the liabilities plus the equity.
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Balance Sheet Profit
While the balance sheet does not show a specific net earnings figure, it does provide a lot of important clues regarding company performance. For example, it shows accounts receivable, cash and investments on the asset side, which are all signs of how much money the business will have available in the short or long term. By comparing these accounts with previous balance sheet versions, analysts can note how much value has increased and deduct how much the company profited between the two periods. The balance sheet also shows how much the business depends on liabilities, which can provide clues on how the company could increase its reported profits.
Limitations
The balance sheet is a static report in a constantly changing world. It takes a snapshot of company accounts and lists them all out in specific categories. But in a business, money is constantly moving; old debts are paid off, new debts are formed, equity is adjusted and assets are bought, sold and depreciated. A balance sheet can never keep up with these changes. An income statement views an entire period to come up with profit figures, while a balance sheet needs to be compared to something else for a true idea of profit.
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Liquidity
What a balance sheet can show is the liquidity of a business, or how much cash it has on hand and how easily it can turn other assets into cash. This is very important when loans and acquisitions are being considered, making the balance sheet a key factor in profit calculations if another company is interested in purchasing the business.
