A Balance Sheet is an important document because it reveals a snapshot of the company and goes far beyod the Profit and Loss Account – for example, a company may show excellent profits in its profit and loss account, but at the same time could be overburdened by the interest on debt that may not have been accounted for lest it reflect badly on the profits. The Balance Sheet comments on the solvency and liquidity of a business, and only a thorough reading of the Balance Sheet reveals what lies beneath all the hype and hoopla generated by a company.
The Balance Sheet reports on the assets and liabilities of a business on a certain date, which is the end-date of the company's financial year. You have to keep in mind that the Balance Sheet is only a picture at the end of the company's financial year and it can be viewed only after it has been published – there may be events subsequent to the Balance Sheet date that have materially altered the company's fortune, and such events may not be contained in the Balance Sheet if they occurred after the date the Balance Sheet was sent into print or published.
What does a Balance Sheet contain?
A Balance Sheet contains three important types of important data:
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Assets
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Liabilities
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Shareholders' equity, comprising of equity share capital, preference share capital and reserves (accumulated profits, share premium, capital and other reserves).
Assets
The assets side of a Balance Sheet typically contains the following data:
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Fixed or long-term assets of the company: These are assets in which the company has invested in for the long run, and the purpose of such assets is to ensure the long-term functioning of the business. These assets are valued after depreciation and comprise the following: (i) land, (ii) factory building, (iii) plant and machinery, (iv) vehicles, (v) intangible assets (i.e., assets that have no physical form but give a business that competitive edge; e.g., patents, copyrights and rights over an asset such as an oil exploration block) and (vi) long-term investments (e.g., investment in other companies' equity, investment in government bonds, term fixed deposits, etc.).
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Current assets or short-term assets of the company: Current assets comprise of inventories (raw material, semi-finished and finished goods), accounts receivable (monies receivable from customers), investments held for trading, and any other short-term assets.
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Cash: This is made up of cash in hand and credit balances in bank accounts.
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Prepaid expenses: These are expenses incurred by the company that do not pertain to the financial year that the Balance Sheet represents, such as tax for the following year paid in advance, rent paid in advance, etc.
Liabilities
Liabilities are made up of:
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Accounts payable, which are represented by money due to suppliers of raw materials, salaries/bonuses payable, outstanding utility (phone, power, Internet, etc.) bills, and any other amount due to a supplier of any other goods or service.
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Long-term financial liabilities comprise of loans taken from financial institutions, money raised from issuing corporate bonds, fixed deposits accepted, mortgages payable, etc.
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Provisions for current tax payable, court rulings, deferred tax provisions and provisions for contingencies that are now payable.
Equity
The equity of a company appears on the liabilities side of a Balance Sheet, and here are its components:
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Common stock: This comprises the equity and the preference class of shares issued by the company. These are issued at the inception and maybe even at later dates when the company needs funds for expansion or diversification.
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Reserves: These are retained profits accumulated over the years, after dividend payments. Reserves also comprise share premiums, which represent premium charged on the issue of equity shares – a company might issue further equity shares when it reaches a certain level and wants to expand. It naturally follows that when the company reaches a good stage of growth, it needs to price its shares at a premium. Reserves created legally (say, Debenture Redemption Reserve) are also included in this heading.
The difference between the assets and the liabilities represents the net worth of a company. Every country has a different set of guidelines that should be followed while drawing up a Balance Sheet. By and large, these guidelines conform to the set of guidelines issued by the International Accounting Standards Committee. If you have planned to invest in the equity of a company, it is important to decipher its profitability and Balance Sheet, and only then step into the waters.
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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved."
