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Financial Statements for Beginners: Making Sense of Balance Sheets

Updated: Sep 19, 2023

A balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It's an important tool for investors, creditors, and other stakeholders who want to understand the financial health of a company. In this blog post, we'll discuss the key components of a balance sheet and how to analyse it to better understand a company's financial position.


Learn more by watching the video and reading the blog post below:



The Basic Structure of a Balance Sheet


A balance sheet consists of three main sections:

  • Assets

  • Liabilities

  • Equity

The assets section represents what a company owns or has control over, while the liabilities section represents what it owes to others. The equity section represents what is left over after all liabilities are paid off.


Assets


Assets can be divided into two categories: current assets and non-current assets. Current assets are those that are expected to be converted into cash within a year, while non-current assets are those that are expected to be held for more than a year. Examples of current assets include cash, accounts receivable, and inventory, while examples of non-current assets include property, plant, and equipment.


Liabilities


Liabilities can also be divided into two categories: current liabilities and non-current liabilities. Current liabilities are those that are due within a year, while non-current liabilities are those that are due after a year. Examples of current liabilities include accounts payable and short-term debt, while examples of non-current liabilities include long-term debt and pension liabilities.

Equity


Equity represents what is left over after all liabilities are paid off. It includes the initial investment in the company, retained earnings, and any additional paid-in capital.


How to Analyse a Balance Sheet


There are several ways to analyse a balance sheet to better understand a company's financial position. Here are a few key metrics to look at:

  • Current Ratio: The current ratio measures a company's ability to pay its short-term obligations. It is calculated by dividing current assets by current liabilities. A current ratio of 2:1 is generally considered healthy.

  • Debt-to-Equity Ratio: The debt-to-equity ratio measures a company's level of debt relative to its equity. It is calculated by dividing total debt by total equity. A debt-to-equity ratio of 1:1 is generally considered healthy.

  • Return on Equity: The return on equity measures a company's profitability relative to the amount of equity invested in the company. It is calculated by dividing net income by total equity. A higher return on equity is generally considered better.

  • Working Capital: Working capital measures a company's ability to meet its short-term obligations. It is calculated by subtracting current liabilities from current assets. A positive working capital is generally considered healthy.

In conclusion, a balance sheet is an important tool for understanding a company's financial position. By analysing the key metrics on a balance sheet, investors and creditors can get a better sense of a company's financial health and make more informed decisions about whether to invest in or lend to the company. It's important to remember that a balance sheet provides a snapshot of a company's financial position at a specific point in time and should be used in conjunction with other financial statements and metrics to get a more complete picture of a company's financial health.

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