Understanding a company's financial statements is essential, even without accounting expertise. Of the three fundamental documents (balance sheet, income statement and cash flow statement), the balance sheet is particularly important. It provides an accurate snapshot of a company's assets at a given date, revealing what it owns and how it is financed.
Specific features of the balance sheet
A summary document, it shows the balance between the company's resources (assets) and their sources of financing (liabilities and shareholders' equity).
The fundamental equation of the balance sheet is as follows: Assets = Liabilities + Equity.
The balance sheet enables us to quickly assess a company's solidity, identify certain risks and facilitate dialogue with financial partners.
Understanding the structure of a balance sheet
The assets side of the balance sheet represents everything the company owns to operate. It is divided into two main categories:
1. Non-current assets (over one year) :
- Intangible assets: patents, trademarks, licenses
- Tangible assets: buildings, land, equipment
- Financial items: investments in other companies
2. Current assets (less than one year) :
- Inventories: merchandise, raw materials and finished goods
- Accounts receivable: what customers owe the company
- Cash and cash equivalents: money available in bank accounts and cash on hand
Effective asset management is essential to a company's financial health. For example, too much inventory or trade receivables can create cash flow problems.
The liabilities side of the balance sheet shows how the company has financed everything it owns. It consists of two main parts:
1. Equity: funds contributed by owners or generated by the company.
2. Long-term financial debts: bank loans to be repaid over several years.
3. Short-term debt: debts to suppliers, taxes payable, etc.
The balance between these two sources of financing reveals whether the company is financially dependent on its creditors.
Balance sheet analysis
Financial ratios are used to summarize balance sheet information into easily interpretable numerical indicators. In particular, they show whether the company is liquid and solvent.
- Liquidity: a company is liquid if it can meet its short-term debts with its current assets.
- Solvency: a company is solvent if it has the capacity to repay all its medium- and long-term debts.
An in-depth analysis of liquidity and solvency requires ratios to be compared over at least three consecutive years, and benchmarked against those of major competitors. Sudden or unusual changes deserve special attention.
In conclusion, balance sheet analysis, far from being the preserve of financial experts, is an accessible and valuable skill for any manager or entrepreneur.
Interested in financial accounting? Join us at ⬇️
Table of content
