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.
Is the accounting record mandatory?
Now that you know what the balance sheet is and all its structure and importance, let us understand the obligation of accounting records, which are used to compile all the financial transactions of your business, including assets, rights and obligations.
The accounting record is mandatory and valid for any type of company. In addition, organizations must also present the recorded facts, which are the financial records themselves cataloged in the daily ledger. To do so, they need to be updated and provide real information on the current moment of the organization.
What are the consequences of not having the balance sheet?
The balance sheet is more than just an obligation. This document can assist in different processes and situations to which your company will be exposed. Therefore, see below the main consequences of not having or keeping your balance sheet updated or at hand.
Defense for tax proceedings
The balance sheet is an important resource of evidences for tax proceedings, and the information in this document can be used during the discussions. However, when a company does not present it, the defense will become more fragile and will prove that the organization is not compliant, and does not even have its documents and processes organized.
Exempt profits above Presumption
According to Income Tax (IT) standards, companies that do not present financial statements that indicate the profit have its revenues demarcated in 8%, which is the limit of presumption of income for companies in the industrial and commercial sector, and in 32% for businesses that operate with the provision of services.
The financial performance of your company will be known with this document, as it reveals important data on profit, among other indicators.
Therefore, by neglecting it, the company will be at the mercy of the cash flow alone, which is not complete enough to aid in performance and strategy analyses that improve the business behavior. In addition, as it is mandatory, your company will not be able to file a request for court-supervised reorganization.
How to calculate indicators with the balance sheet?
Indicators are important tools for knowing the performance and health of a company. Some metrics aid in the balance sheet evaluation process and allow you to learn about the economic and financial situation in a reliable and up-to-date way so you can make the best decision. Here is how to calculate some important indicators:
- Return on assets = net income/total assets;
- Return on shareholders’ equity = net income/shareholders’ equity;
- Asset turnover = net income/shareholders’ equity;
- Current liquidity = current assets/current liabilities;
- Overall liquidity = (current assets + long-term assets) / (current liabilities + long-term liabilities);
- Level of indebtedness = liabilities/shareholders’ equity.
Now that we understand what the balance sheet is, it is essential that you establish it in your company. That way, liquidity indices are ensured with the purpose of leveraging your business, in addition to correctly meeting the accounting standards imposed on all companies.
Did you like this content? Then check out how to make a good indicator management and learn about the importance of this task for your company!