Companies often focus on their income statement and cash flow statement without much consideration of the balance sheet. This is a mistake! The balance sheet is important because:

– Shows the effect of past decisions.
– Tracks the liquidity of a company’s cash position
– Records what the Owner’s Equity position is at different time intervals
– Directly affected by the Cash Flow and Income Statements, which reflect the state of the company’s operations
– Quickly show the condition of a business

The balance sheet illustrates how a company’s assets, liabilities, and net worth are distributed at a given point in time or period of time. The Balance Sheet set format facilitates analysis. The order of the categories broken down in the Balance Sheet is arranged in decreasing order of Liquidity and Immediacy for Assets and Liabilities, respectively. Because the Balance Sheet shows changes in the Company’s Debt, Equity, and condition over time, it is an excellent tracking and control document. Before we get into balance sheet analysis, let’s examine the important sections of the balance sheet (see the sample balance sheet (plain format) at the end of this article).

– Current Assets: Cash, Government and Negotiable Securities, Notes Receivable, Accounts Receivable, Inventories and Prepaid Expenses. Any other item that can be converted to cash within a year.

– Fixed Assets: Land, Plants, Equipment, Improvements to Leased Premises. Other items that are expected to have a commercial useful life that can be measured in years.
— Depreciation applied to items that wear out.

– Other Assets: Intangible assets such as Copyrights, Patents, Exclusivity of Contracts and Documents Receivable from Employees and Officers of the Company.

– Current Liabilities: Accounts and Documents Payable; Expenses that Accumulate (such as Wages, Wages, Withholdings, FICA); Tax Payable; Current part of the Long-Term Debt; and other Obligations maturing within one year.

– Long-Term Liabilities: Trust Deeds, Mortgages, Equipment Loans and Long-Term Bank Loans. All of these are net of the current portion of Long-Term Debt (appears as Current Liabilities).

– Net Worth: Assets minus Liabilities.

– Owners’ equity: shareholding of directors, retained earnings and other equity.

balance sheet analysis

Three ways to quickly determine the health of your business:

1) Analyze working capital: Subtract current liabilities from current assets to determine your level of working capital. Cash is only part of working capital.
a) Illiquid businesses may find it difficult to obtain future loans. Solutions are working capital loans, fixed asset sales, accounts payable financing, or securing new capital investments.

2) Compare Fixed Period Balance Sheets – By comparing similar time periods, you can quickly spot trends and weak areas, which after investigation can determine the reasons behind them. If you’re an established business, compare year-end balance sheets. If you are a new business, compare Balance Sheets from one quarter to the next. After analysis, problem areas and strong areas jump right off the page!

3) Current and Acid Test Ratios – These analyzes are based on percentages versus dollars, making it easy to compare to industry and area norms of similar companies.
a) Current Ratio: Measures the Liquidity of a Company or its ability to meet current obligations in the next year.

I. Formula: Current Assets ÷ Current Liabilities
ii. For the analysis to mean anything, it is important to understand what this ratio represents. Factors that affect the current ratio are the type of inventory, the quality of accounts receivable, the timing of the sales cycle, the time of year, etc. A ratio of 2.0 generally represents a healthy company, but it really depends on the type of company and the industry.

b) Acid Test: The “Fast Ratio” is calculated by dividing the Most Liquid Assets of a Company by the Current Liabilities. Liquid Assets include Cash, Securities and Current Accounts Receivable. A ratio of 1.0 generally represents a healthy company, but is company and industry specific.

Note: Benchmarks of a current ratio of 2.0 and an acid test of 1.0 (quick ratio) are not industry specific. Be sure to research healthy levels for businesses that are a lot like yours. Trade associations, banks, and Dun & Bradstreet are good sources for comparative ratio information.

Footnotes: Footnotes to assumptions and calculations are very important to an outside reader, such as a banker. A bank would be interested in knowing how restricted its Assets are, so an explanation would be necessary for each item of Asset. An investor would be very interested in the details of Homeownership. A banker would also be interested in a breakdown of accounts payable, detailing exactly when liabilities are due.

Balance Sheet Example (Simple Format)

Assets
Current assets
Fixed assets

• (Less) Accumulated Depreciation
• Net fixed assets

Other assets
total assets
passive
current liabilities
Long term passives
Full responsibility
NET VALUE / OWNER’S EQUITY
Total liabilities and net worth