Do you know what a balance sheet is? Among all your accounting reports, they’re considered the most important. However, many business leaders still neglect them.
You can use this report to help the financial management of your company and verify your assets, rights, liabilities, third party capital, profit reserves, and sources of income.
Interested in this subject? Want to get a better understanding of balance sheets? Then this article was made for you. Take a look!
What is a balance sheet?
It’s a formal accounting statement of all of an accounting entity’s financial transactions for a given period. Thus, all of the accounting rows detailing credits and debits are those that appear in an organization’s accounting ledger.
Through this statement one can determine the balance of your assets, rights and liabilities. You can also identify all your sources of income from any accounting entity.
Therefore the balance sheet and income statement are considered indispensible to the financial planning for any company.
How is a balance sheet structured?
Every balance sheet is structured based on a chart of accounts, which is defined when a company begins its activities. Every balance sheet needs to consist of three accounting categories which are as follows:
- Assets: made up of all the assets and rights of an accounting entity. They are divided into short-term, long-term and fixed assets;
- Liabilities: these represent the financial obligations and third party capital of an accounting entity.
- Net Assets: is the owner’s or shareholders’ equity. The items that make up this value may be found in the asset accounts.
How should you prepare your balance sheet?
It’s a good idea to use a small balance sheet each month to verify whether all the transactions listed in the accounting ledger are correct.
When you have many alterations of value, it’s possible that one or more income or expense items have been left out of your ledger.
Due to this limitation, you always need to make adjustments to your accounts so that they are in keeping with reality, and the total of these alterations in terms of assets and liabilities have to be equal.
Is your balance sheet a decision making analysis tool?
Yes. We should consider the balance sheet an analysis tool for any business, because it shows the overall situation of its accounts. It supplies managers with financial data that will help them drive their company’s profitability and rate of return on investment. Take a look!
Whenever the assets of your business are greater than your liabilities, we are talking about positive net worth. When the assets and liabilities are equal this indicates zero net worth. In the same way, when your liabilities are greater than your assets it indicates negative net worth.
Every time that your company has zero or a negative net worth, it’s a good idea to take steps to overcome this by broadening your sources of revenue, investing more capital or collecting unpaid debts.
What is the importance of a balance sheet to financial indicators?
Through this document, you can analyze and monitor some of your company’s financial indicators, sometimes with the help of other documents. This shows that a balance sheet is an instrument used for analysis and decision making just like indicators.
Take a look at these five indicators and the results that they offer.
Net profit margin
This margin indicates how much money your company generates with every sale or service it offers.
To calculate it, divide the total revenues for a given period by the net profits, which can be found in the income statement. Then multiply this result by 100 to determine the net profit margin percentage.
Profit growth rate
One of the totals found in the balance sheet is the company’s accumulated profit during its entire existence.
With the current year’s balance sheet and those from previous years in hand, you can calculate your company’s profit growth year after year.
Return on equity
By dividing the equity listed on the balance sheet by the company’s net revenues, you can calculate the return on equity percentage, which indicates how much money your capital and other equity investments generate for your business.
Return on assets
Specifically in relation to the document’s assets, such as vehicles, real estate, equipment and mobile assets, the return on assets shows how much money they generate, taking into consideration the investments made in acquiring them.
Beyond this, to obtain more specific results, you can make this calculation just using a portion of the revenues and one element of the assets.
For example, an insurance company that offers corporate cars to its salespeople can divide the total value of signed contracts by the value of the use of the car utilized by the salesperson responsible to achieve these sales.
Or, when dealing with the opening of a new office, you can divide the total revenues by the equity investment made to open it. You need this to determine, within a more complex panorama — which involves other factors — the total return on investment of this expansion.
To obtain this ratio, you need to sum the company’s short term liabilities and divide them by its total assets. Then you can multiply this result by 100 to obtain this ratio in percentage form.
Analyzing this indicator, the lower the ratio is, the better it is for your company. If it is very high, it’s time to evaluate your costs and even your processes one at a time to decrease your debt and increase your gross and net revenues.
Now that we understand the importance of the balance sheet, it’s crucial that each accounting entity have its own. This will ensure that your company has a good liquidity ratio so that your managers can leverage your business, and that it is in compliance with the accounting norms required of all companies.
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