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How to Read A Balance Sheet

how-to-read-a-balance-sheet

Reading a balance sheet can be straightforward, or completely confusing, depending on whether you know how to interpret what you’ve got in front of you.

In a nutshell, a balance sheet summarises all the assets and liabilities of a business. This means that everything a business owns and owes is set out, and from that you can measure a business’ net worth by subtracting what it owes, from what it owns. So the very basic balance sheet equation is:

  • Assets – liabilities = Shareholders Equity

A balance sheet can also be referred to as a ‘statement of financial position’ because it displays a snapshot of the liabilities and assets of a company at a specific point of time. The reason it is called a balance sheet is that both sides of the equation have to balance.

Here is a free, downloadable Balance Sheet Template to give you a visual sense of how liabilities and assets are laid out in a balance sheet.

Assets

Assets are made up of anything that a company has control over. It doesn’t matter who actually financially owns the asset, as long as the company has control over it, then it is considered to be an asset. Assets can be broken up into three categories:

  1. Current assets: Includes assets the business plans on keeping for a limited period of time, usually under 12 months. It can include things like cash in a bank account, short-term investments and stock.
  1. Fixed assets: These are more long-term assets that a company plans on keeping. Usually it’s things like office equipment or cars.
  1. Intangible assets: These are the assets of a company that can’t be touched. It includes intellectual property such as trademarks and patents.

Liabilities

Liabilities represent the total value of how much the company owes to any other entity. In simple terms, it’s what the company owes to other people. Liabilities come in two forms:

  1. Current or Short-term liabilities: These are normally the items a company is expected or expecting to pay for within a 12 month period. It will often include overdrafts that have to be settled and short-term loans.
  1. Non Current or Long-term liabilities: These are liabilities that are not required to be paid within a 12 month period. It may include a long-term loan, a director’s loan to the business or a secured bill.

Shareholder’s and Owner’s Equity

This is the section of the balance that represents funds generated from share allocation and retained profits or accumulated losses resulting from the companies commercial performance.

Owner’s equity shouldn’t be confused with how much a business is valued at for a sale because a balance sheet doesn’t always take into account all aspects of a business that may be valuable including intangible assets, customer base, new licence agreements, and so on.

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