In this blog I am going to take an important topic "how to read a balance sheet" because now a day reading of a balance sheet is equally important fot a common man, who invest his money in share market as an investor.
First of all we have to know what is balance sheet. Balance sheet is a financial statement which shows the financial position of a company or we can say that balance sheet reveals the company's assets, liabilities and owners fund or in other words balance sheet shows the net worth of the company. Balance sheet is a "statement of financial position," of a company. The balance sheet, along with the income statement and cash flow statement, makes the complete mirror of any company's financial position.
If any body wants to invest in share market, it is very important to understand, about the balance sheet and to analyze it, to understand the financial strength of the company in which the investor is going to invest.
So let us understand How the Balance Sheet Works.
The main formula behind balance sheets is:
Assets = Liabilities + Shareholders\' Equity
This means that assets is a main pillor for a company to operate and balance the company's financial obligations, and retained their earnings.
The Assets are the component for a company to operate its business, and the component of liabilities and equity are two sources that support these assets.
Owners' equity, is the amount of money initially invested into the company plus any retained earnings and it represents a source of funding for the business.
If the company is traded publicly the amount of equity of shareholders is also treated as equity fund.
It is important to note that a balance sheet is a picture of the company's financial position at a single point in time.
Types of Assets
Current Assets
A current asset is cash and any other asset of the company that will be turning to cash within one year from the date shown on the top of the company's balance sheet, but If a company who is working in a operating cycle and the operating cycle is longer than one year then an asset that will turn into cash within the length of its operating cycle is considered to be as a current asset.
So usually the life span of the Current assets is one year or less, meaning that the assets are current assets which can be converted easily into cash.
It includes
cash in hand and cash at bank
cash equivalents,
accounts receivable
inventory.
Cash, the most important element of current assets, it includes cash in hand and cash at bank.
Cash equivalents are very safe assets that can be readily converted into cash such as promissory notes, treasury bills, hundies and convertible bonds. Accounts receivables are the arrangements for short-term obligations owed to the company by its clients. Now a days companies are going to sell their products and services on credit to build their customer base. These obligations are held in the current assets until they are paid off by the clients.
Inventory represents
The raw materials,
Work-in-progress goods
Company's finished goods.
The definition of inventory account is differ among the company's depending upon the company rules. For example, a manufacturing firm will carry a large amount of raw materials, while a retail firm caries none. The inventory for a retailer's company is treated as the goods purchased from manufacturers and wholesalers.
Non-Current Assets
Non-current assets are assets that are not turned into cash easily and have their lifespan is more than a year.
There are basically two types of non current assets
Tangible assets
Intangible assets
Tangible assets are the assets that can be see and touch such as machinery, computers, buildings and land.
Intangible assets are the assets that can not be see or touch such as goodwill, patents or copyright or we can say that these assets are not physical in nature, but they are the resources that can make or break a company.
Non-Current Assets are either tangible assets or intangible assets.
Depreciation is calculated and deducted from most of these assets. One more confusing word come forward what is Depreciation?
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes. For tax purposes, businesses can deduct from the cost of the tangible assets as business expenses; however, businesses must depreciate these assets in accordance with IRS ( Indian Revenue Services) rules about how and when the deduction may be taken.
One more confusion need to clear that whether depreciation is also allowed on Intangible assets?
So the answer is as per section 32(1)(ii) of IT Act depreciation can be claimed on know-how, patents, copyrights, trade marks, licences,franchises or any other business as intangible assets if acquired on or after the 1st day of April, 1998. It can be wholly or partly, by the assessee and used for the purposes of the business or profession. Goodwill can also be generated in the event of purchase of division as per the accounting standards. The Income Tax Act, specifically doesn’t allow depreciation on acquisition of goodwill but as per the judgement passed by Supreme Court in case of Smifs Securities Limited it was held that goodwill is an asset.
Different types of Liabilities
On the other side of the balance sheet are for the liabilities side.
Liabilities are the financial obligations a company owes to outside parties. The liabilities can be current or long-term.
The Long-term liabilities can be the debts or non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet.
Current liabilities are the liabilities that will come due, or must be paid, within one year.
This includes both short-term borrowings and long-term borrowing.
Shareholders' Equity
Shareholders' equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings (after deduction of taxs) into the company, these net earnings will be transferred from the income statement to the balance sheet under the head of shareholder's equity account.
This account represents a company's total net worth. The balance of total assets on one side have to equal to the total liabilities plus shareholders' equity on the other.
If we see the above criteria the balance sheet is broken into two areas.
Assets are on the top and below the company's liabilities and shareholders' equity.
It is also clear that the balance sheet is in balance where the value of the assets equals the combined value of the liabilities and shareholders' equity.
So it is clear that the aspect of the balance sheet is organized into two sections e.i.the assets and the liabilities sections.
For the asset side, the accounts are classified most liquid.
For the liabilities side, the accounts are organized from short to long-term borrowings and other obligations.
This is what the balance sheet is. We saw what are the accounts taken in balance sheet but it is equally important to analyze the balance sheet of a company because if we are a investor we have to know about the balance sheet and also know how to analyse the balance sheet.
So let's see the how to analyse the Balance Sheet.
Balance sheet is a set of financial information and analyzing of balance sheet is a techniques to examin the balance sheet with given information within the balance sheet.
The main method to analyse the balance sheet through financial ratio analysis.
To analyse the financial ratio the formulas used to know the gain from the company and its operations.
The main types of ratios that use information from the balance sheet are
Financial strength ratios
Activity ratios.
Financial strength ratios, such as the working capital and debt-to-equity ratios, provide information on how well the company can meet its obligations and how the obligations are leveraged.
The financial strength ratio can help to give an idea to the investors the financially stability of the company. Activity ratios focus mainly on current accounts to show how well the company manages its operating cycle (which include receivables, inventory and payables). These ratios can provide insight into the company's operational efficiency.
I post this blog because I think It is important that all investors must know how to use, analyze and read this important financial document. Because there are so many investor want to invest in equity market but feel fear because many do not have a financial knowledge.
I believe that my blog gives a lots of knowledge because I make it easy to understandable. If any of my reader want any improvement, information kindly leave the comments.
Thanks for supporting
First of all we have to know what is balance sheet. Balance sheet is a financial statement which shows the financial position of a company or we can say that balance sheet reveals the company's assets, liabilities and owners fund or in other words balance sheet shows the net worth of the company. Balance sheet is a "statement of financial position," of a company. The balance sheet, along with the income statement and cash flow statement, makes the complete mirror of any company's financial position.
If any body wants to invest in share market, it is very important to understand, about the balance sheet and to analyze it, to understand the financial strength of the company in which the investor is going to invest.
So let us understand How the Balance Sheet Works.
The main formula behind balance sheets is:
Assets = Liabilities + Shareholders\' Equity
This means that assets is a main pillor for a company to operate and balance the company's financial obligations, and retained their earnings.
The Assets are the component for a company to operate its business, and the component of liabilities and equity are two sources that support these assets.
Owners' equity, is the amount of money initially invested into the company plus any retained earnings and it represents a source of funding for the business.
If the company is traded publicly the amount of equity of shareholders is also treated as equity fund.
It is important to note that a balance sheet is a picture of the company's financial position at a single point in time.
Types of Assets
Current Assets
A current asset is cash and any other asset of the company that will be turning to cash within one year from the date shown on the top of the company's balance sheet, but If a company who is working in a operating cycle and the operating cycle is longer than one year then an asset that will turn into cash within the length of its operating cycle is considered to be as a current asset.
So usually the life span of the Current assets is one year or less, meaning that the assets are current assets which can be converted easily into cash.
It includes
cash in hand and cash at bank
cash equivalents,
accounts receivable
inventory.
Cash, the most important element of current assets, it includes cash in hand and cash at bank.
Cash equivalents are very safe assets that can be readily converted into cash such as promissory notes, treasury bills, hundies and convertible bonds. Accounts receivables are the arrangements for short-term obligations owed to the company by its clients. Now a days companies are going to sell their products and services on credit to build their customer base. These obligations are held in the current assets until they are paid off by the clients.
Inventory represents
The raw materials,
Work-in-progress goods
Company's finished goods.
The definition of inventory account is differ among the company's depending upon the company rules. For example, a manufacturing firm will carry a large amount of raw materials, while a retail firm caries none. The inventory for a retailer's company is treated as the goods purchased from manufacturers and wholesalers.
Non-Current Assets
Non-current assets are assets that are not turned into cash easily and have their lifespan is more than a year.
There are basically two types of non current assets
Tangible assets
Intangible assets
Tangible assets are the assets that can be see and touch such as machinery, computers, buildings and land.
Intangible assets are the assets that can not be see or touch such as goodwill, patents or copyright or we can say that these assets are not physical in nature, but they are the resources that can make or break a company.
Non-Current Assets are either tangible assets or intangible assets.
Depreciation is calculated and deducted from most of these assets. One more confusing word come forward what is Depreciation?
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes. For tax purposes, businesses can deduct from the cost of the tangible assets as business expenses; however, businesses must depreciate these assets in accordance with IRS ( Indian Revenue Services) rules about how and when the deduction may be taken.
One more confusion need to clear that whether depreciation is also allowed on Intangible assets?
So the answer is as per section 32(1)(ii) of IT Act depreciation can be claimed on know-how, patents, copyrights, trade marks, licences,franchises or any other business as intangible assets if acquired on or after the 1st day of April, 1998. It can be wholly or partly, by the assessee and used for the purposes of the business or profession. Goodwill can also be generated in the event of purchase of division as per the accounting standards. The Income Tax Act, specifically doesn’t allow depreciation on acquisition of goodwill but as per the judgement passed by Supreme Court in case of Smifs Securities Limited it was held that goodwill is an asset.
Different types of Liabilities
On the other side of the balance sheet are for the liabilities side.
Liabilities are the financial obligations a company owes to outside parties. The liabilities can be current or long-term.
The Long-term liabilities can be the debts or non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet.
Current liabilities are the liabilities that will come due, or must be paid, within one year.
This includes both short-term borrowings and long-term borrowing.
Shareholders' Equity
Shareholders' equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings (after deduction of taxs) into the company, these net earnings will be transferred from the income statement to the balance sheet under the head of shareholder's equity account.
This account represents a company's total net worth. The balance of total assets on one side have to equal to the total liabilities plus shareholders' equity on the other.
If we see the above criteria the balance sheet is broken into two areas.
Assets are on the top and below the company's liabilities and shareholders' equity.
It is also clear that the balance sheet is in balance where the value of the assets equals the combined value of the liabilities and shareholders' equity.
So it is clear that the aspect of the balance sheet is organized into two sections e.i.the assets and the liabilities sections.
For the asset side, the accounts are classified most liquid.
For the liabilities side, the accounts are organized from short to long-term borrowings and other obligations.
This is what the balance sheet is. We saw what are the accounts taken in balance sheet but it is equally important to analyze the balance sheet of a company because if we are a investor we have to know about the balance sheet and also know how to analyse the balance sheet.
So let's see the how to analyse the Balance Sheet.
Balance sheet is a set of financial information and analyzing of balance sheet is a techniques to examin the balance sheet with given information within the balance sheet.
The main method to analyse the balance sheet through financial ratio analysis.
To analyse the financial ratio the formulas used to know the gain from the company and its operations.
The main types of ratios that use information from the balance sheet are
Financial strength ratios
Activity ratios.
Financial strength ratios, such as the working capital and debt-to-equity ratios, provide information on how well the company can meet its obligations and how the obligations are leveraged.
The financial strength ratio can help to give an idea to the investors the financially stability of the company. Activity ratios focus mainly on current accounts to show how well the company manages its operating cycle (which include receivables, inventory and payables). These ratios can provide insight into the company's operational efficiency.
I post this blog because I think It is important that all investors must know how to use, analyze and read this important financial document. Because there are so many investor want to invest in equity market but feel fear because many do not have a financial knowledge.
I believe that my blog gives a lots of knowledge because I make it easy to understandable. If any of my reader want any improvement, information kindly leave the comments.
Thanks for supporting
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