This article is an introduction to the balance sheet. The following questions will be answered:

• What is a balance sheet?
• Why is it important?
• How does it function? What is its structure?

What is a Balance Sheet? Why Is It Important?

The three financial statements act together to give a fundamental view of a company's business within the period of time. The balance sheet is one of them and it gives a snapshot of what a company owns and owes. With the help of the balance sheet, investors as well as business owners can calculate the rate of return for different types of capital. The calculation of the changes in the balance sheet between different periods of time can also provide a snapshot of the major asset movements and business decisions.

Structure of a Balance Sheet

The structure of the balance sheet is simple. It is a straightforward equation:

Asset = Liability + Equity

Assets: Properties a company owns. There are current assets and non-current assets. Current assets include items like cash and inventories. Non-current assets include items like land and machinery.

Liabilities: Properties a company owes. Also categorized as current liabilities and non-current liabilities. Current liabilities are items like Account Payable. Non-current liabilities are items like long-term debt.

Equity: Properties a company takes the control right. Usually comes from the investment of investors (such as stocks) or net income during a period of time.

The balance sheet categorizes all of a company’s properties (assets) under the three categories, following the equation above. This equation is intuitive. A company pays everything it owns (assets) either through borrowing money (liabilities) or investments from investors (equity).

Usually, when people look at the balance sheet, they examine whether there is a one-off item. For example, sometimes debt could take a huge proportion of the balance sheet. In this case, there might be a risk that the company cannot pay back the debts with the other assets it has.

Another important function of the balance sheet is to calculate how effective the company is using its assets. This is also following common sense because, in reality, all assets are purchased to generate a higher return. For example, by dividing the revenue by total assets, we have a sense of how effectively the company uses assets to generate revenues.

A more detailed tutorial on how to analyze the balance sheet through Excel is here: Excel: Balance Sheet Analysis.

In short, the balance sheet is a powerful and informative financial statement, as it indicates the capital structure of a company. In the following articles, we will break down the details of the elements under the balance sheet.