Stock basics - Balance Sheet

It is a financial statement that sums up a company’s assets, liabilities and shareholders’ equity at a particular point in time. These three sections provide investors an idea about what the company owns and owes, and the amount invested by shareholders.

Significance

Although a balance sheet should be the starting point of a company’s analysis, it is often ignored by investors. One of the major reasons is that it is mandatory for companies to disclose earnings every quarter, but disclosing balance sheet is required only at the end of year. However, it is the balance sheet that indicates a company’s true earnings potential.

In Greater Detail

A company can acquire assets in two ways. The first is by borrowing money, which is called liability. The second is contribution from its shareholders (shareholders’ equity). So, items on a balance sheet can be presented in the form of an equation, the left of which is assets and the right is the sum of liability and shareholders’ equity. Here we look at what constitutes a company’s assets, liability and shareholders’ equity.

A Assets. Companies classify their assets under two heads.

Current Assets. These are assets that the company expects to be converted into cash in a year. An example is inventory that it expects to sell in a year and receive cash for it. Companies also sell goods or provide services on credit. The cash they expect to receive in lieu of it is also an asset, and is called ‘receivables’. A company’s short-term investments, cash and bank balance are also called current assets.

Non-current Assets. These are assets that the company intends to use for more than a year, e.g. land and machinery. Some intangible things, such as copyrights and patents, also fall under this category.

B Liability. Like assets, liability can also be short-term and long-term.

Current Liability. These are debt or liabilities due in year. For example, a company may have taken a short-term loan, or it could be liable to pay for raw materials it has purchased on credit.

Non-current Liability. These are the liabilities that will become due after a year.

C Shareholders’ Equity. It is the amount contributed by the owners of a company. Another item that gets added to equity is the company’s residual net profit (profit left after paying dividends to its shareholders).