What is a balance sheet and what does it say about an SME?
Annoyingly, it is often overshadowed by another important report that shows the key figures of the company, the profit and loss account. The income statement may be simpler to understand, but looking at the balance sheet can be much more fruitful at times.
What is the balance
What the balance sheet contains
How to look at the balance sheet
The balance sheet is a document describing the key figures of a company, the main purpose of which is to provide information about the company’s assets and how its assets and operations are financed. The balance sheet always gives an up-to-date picture of the situation on a given day, rather than over a longer period, such as the profit and loss account. The balance sheet must always be balanced, literally.
Compared to the profit and loss account, the balance sheet gives a more up-to-date picture of the financial situation of the company – even if the current financial year described in the profit and loss account is profitable, the company may still be in large debt and in financial distress.
However, the broadest picture of a company’s financial situation is obtained by looking at the balance sheet and profit and loss account together. We know this is important for every key person in the company. Therefore, using StatBun’s reports, it is very easy to compare the balance sheet and profit and loss account.
The balance sheet contains two sides, assets and liabilities.
Equivalent: company assets
Answer: how the assets of the enterprise are financed
The same is true for all the assets of the company. It can include, for example, the company’s equipment, securities, the value of its stock, real estate, patents, rights, receivables and, of course, cash. The listing of assets starts with items that can be converted into cash (e.g. real estate) and the lowest item on the list is cash and cash equivalents
For example, goodwill, development costs and patents
Tangible fixed assets
For example, real estate, vehicles and machinery
For example, shares in enterprises of the same group, claims on associated enterprises and other shares
Examples of equivalents – variable equivalents:
For example, raw materials, finished products and prepayments
For example, trade receivables, loan receivables and accrued income
For example, shares and securities, the business must not be materially dependent on them.
The purpose of the “to be answered” section is to explain how the company’s assets are financed. The forms of financing can be equity, which refers to the company’s own financing, and debt, which refers to debt.
Equity capital consists of the entrepreneur’s or owner’s own investments in the enterprise and the profit generated by the enterprise’s activities. Equity capital never has a repayment obligation.
Debt refers to the debt that a company has to repay. It is divided into short-term and long-term debt, the former to be repaid in less than a year and the latter in more than a year.
In addition, the liability side may also include the accumulation of accruals and mandatory provisions. The cost of accruing accruals has already been deducted for tax purposes, but has not yet been realised. Mandatory provisions are expenditure likely to be incurred in the future. They are released when the expenditure declared in the reserve is incurred.
You should try to see the balance sheet as a whole. The most important thing is to understand the relationships between the different parts of the balance sheet.
The balance sheet tells you quite a lot on its own, but when you look at it together with the profit and loss account to understand the right activities behind the figures, you get the broadest possible picture of the balance sheet and the company’s financial situation.
The economic analysis has its own ratios for solvency, liquidity, return on capital and working time. These are calculated using both the profit and loss account and the balance sheet figures. The ratios compare either the figures in the profit and loss account and the balance sheet (e.g. return on capital and turnover times), the different sides of the balance sheet, i.e. the matching and matching figures (e.g. liquidity ratios, current ratio and quick ratio) or the ratio of assets to liabilities (e.g. solvency ratio, equity ratio). It is therefore important to take all of the above into account when assessing the financial situation of a company.
If a company has a large amount of assets on the asset side and a clear majority of the assets on the liability side are recorded as equity, the company is in a strong financial position. In this case, the activity is currently financed from own resources, perhaps debt.
If, on the other hand, there is a lot of debt on the assets side of the company, this means that the company has financed its operations with debt. In this respect, the balance sheet usually gives a truer picture than the profit and loss account. Even if the company has a significant profit at the time, but has a large amount of debt on its balance sheet, it is still a debtor. However, this is not always necessarily a bad thing, especially if the company has sought to accelerate its growth with foreign capital.
However, if the majority of the debt is short-term debt, it may mean that the company has only financed its operations temporarily with debt. The debt may not have been paid off yet
A company can be very profitable from an income statement point of view, and in a period of low interest rates, even a large amount of borrowing may not necessarily show up in the income statement as more than a small interest expense. However, the balance sheet shows the total amount of loans, which, especially with rising interest rates, will also affect the profit and loss account in the future and the company’s ability to pay the repayments and interest on the loans. The risk level of the company is much higher with a large amount of loans and is not reflected in the profit and loss account.