What is a balance sheet in simple words? What information does it provide?
A balance sheet is a company’s financial statement in business management. It shows the assets, expenditures, and stockholder ownership of a company at a particular time. A balance sheet helps in calculating investor returns. It helps in assessing a company’s financial structure.
It is a financial statement that shows how much a firm possesses and how much it owes to others. Moreover, balance sheets also assess how much money shareholders have invested. Balance sheets can be combined with other financial analytical tools to conduct basic analysis.
Balance sheets can help conduct financial ratio analysis. A balance sheet is a report that shareholders and other stakeholders utilise. It helps them understand an organisation’s financial viability. It allows them to assess the pace at which the firm produces profits.
They also use balance sheets to compare existing financial resources and debts to assess the company’s stability. Financial analysts use balance sheets while assessing a company’s current performance with previous years.
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What are the four purposes of a balance sheet?
A balance sheet serves the following purposes in the realm of business.
- Helps the Management
Management of a company requires detailed information before making any decision about the company’s future. A balance sheet is an overview of a company’s performance over a given period of time. It helps the management ascertain the company’s assets, liabilities, liquidity ratio, working capital, and availability of funds for future ventures.
Management may opt to pay off the debts based on balance sheet evaluations from its current level if it is perceived to be greater than the industry standard. As a result, researchers of accounting dissertation writing services provider have elaborated all the purposes that a balance sheet can serve in the management of a company:
- Recognition of current concerns
- Projection of possible issues
- Informs the management to take measures for path correction
- Helpful for Financial Institutions
A balance sheet assists financial institutions in determining whether or not to give loans to a company. The balance sheets show the current debt and equity structure. They also evaluate the condition of total assets.
These reports assists banks in determining if the company is excessively borrowing and does not have the capacity to take more loans. Based on balance sheet reports, the banks do not give loans to a company with a limited capacity to service the loans.
- To Assess the Strengths and Weaknesses
Balance sheets help companies in evaluating their strengths and weaknesses. Companies can get a good sense of their liquidity by comparing existing assets with outstanding obligations.
In other words, balance sheets display how much cash companies have on hand. Companies’ decision to move ahead with an investment or expansion depends upon their liquidity ratio. Companies can better understand their efficiency by comparing the balance sheets with income statements.
It informs the upper management how well their company is utilising the available resources. So, if the company is not utilising its resources properly, companies can develop strategies to mitigate the situation. A company that has a better understanding of its financial structure can use it to gain a competitive advantage.
- To Retain and Attract Investors
Investors and shareholders are only concerned with their profits, and if they are not getting the due dividends, they might shift to other companies. Investors need to know that their money is in good hands, and they will get the promised value on their investment.
So a company which has a better understanding of its financial structure can take measures to address the grievances of its investors. Moreover, witty investors analyse the financial structure of a company before investing in it. So, if a company has a good balance sheet, it will be able to attract more investment.
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How does a balance sheet help in decision making?
A balance sheet plays an important role in decision making. It is helpful for the management, investors or shareholders. A company’s management that has a clear overview of its company’s financial health takes appropriate measures and develops sound strategies.
Suppose there is an oil company that wants to switch to renewable energy. Changing your primary product means that initially, the cash outflow will surpass the cash inflow and hence it will lead to lower dividends to shareholders.
But if the company has a clear idea about its liquidity, debts, and assets will prepare better strategies to shift to renewable energy. Balance sheets are helpful in strategy building, which considers the financial condition of a company and helps make informed decisions.
Similarly, investors review the balance sheets first before investing. If the company can provide them with good returns on their investment, they go ahead with it. If the company’s balance sheets are weak, investors do not risk investing their money. So, balance sheets help investors assess the financial viability of a company.
Why is the balance sheet important?
Balance sheets are important documents since they keep business owners up to date on their business’s financial situation. Several company owners remain oblivious of their company’s financial health. It is because some company owners do not review their balance sheets. They realise it when it is too late, and hence they declare bankruptcy.
On the contrary, if the upper management prepares balance sheets regularly and reviews them are aware of their strengths and weaknesses. They get a clear idea of their company’s financial standing, and it helps them make informed decisions to avert a disaster.
Balance sheets are also crucial since they inform banks about the company’s eligibility for new loans or financing. Present and prospective investors may comprehend where their money is going and what they might expect in the future by looking at balance sheets. Investors like firms with a lot of cash because it means the company will expand and succeed.
Learning how to comprehend balance sheets is critical for company managers and accountants. These reports provide a brief assessment of a company’s financial situation. Without this perspective, company owners and accountants might take actions which have a detrimental impact on the financial health of their organizations.