Understand The Balance Sheet To Build Trust With Finance

In this post on understanding Financial Statements, we look at the balance sheet. People tend to perceive others who speak their language fluently as more competent and knowledgeable. For data and analytics leaders engaging with Finance teams, being able to speak in a language familiar to the finance professionals can enhance the perception of the leader's expertise and credibility.

And when information is presented in a familiar language, it is processed more easily, leading to a more positive perception of the communicator and the information being conveyed.

What is a Balance Sheet?

A Balance Sheet is a statement of a company’s assets (the items it owns) and financing (debt and equity). It communicates exactly how much a company or organization is worth, commonly referred to as its “book value.” It is typically prepared and distributed quarterly or monthly, based on legal requirements or company policy.

What’s its Purpose?

A Balance Sheet is an excellent way to present stakeholders with a big-picture view of a business. It can serve two different purposes, depending on whether it’s viewed internally or externally.

When reviewed internally, it can indicate whether a company is succeeding or failing and whether to modify targets and/or activities. Internal decision-makers can use these insights to address failures, capitalize on successes, and take advantage of new opportunities.

When reviewed externally, it can provide information on company resources and financing activities. Potential investors can use this information to decide whether to invest. Auditors can also use this information to ensure compliance with reporting laws.

A Balance Sheet is always based on the past because it presents data from a specified period of time. Though it is often used to predict future performance, it’s important to remember that past performance is no guarantee of future results.

Snapshot: Balance Sheet

• Used to assess financial position
• Measures liabilities, assets, and shareholder equity
• Typically starts with cash balance and ends with retained earnings
• Expressed as a snapshot in time, therefore, it should have a specified date (usually the end of a reporting period)

What’s Included in the balance sheet?

A balance sheet contains three main elements: assets, liabilities, and equity.

1) Assets: An asset is anything a company owns that has an inherent, quantifiable value. The balance sheet typically records assets as positives (+).

2) Liabilities: A liability is anything a company owes (money owed to a debtor, for instance). Liabilities are typically recorded as negatives (-).

3) Equity (aka Shareholder’s Equity): Equity is anything that belongs to the business owners after liabilities are covered.

Equity can take two forms:

• Shares (Equity Capital): Investment in exchange for some degree of ownership
• Retained Earnings: The net profit a company generates and retains

Ratios Used with the Balance Sheet

The following ratios can be calculated using information found on the balance sheet. They are often called “liquidity ratios” since they indicate a company’s ability to pay its obligations as they come due:

Current Ratio = Current Assets (cash + accts rec.+ inventory + other assets) / Current Liabilities. This ratio is also referred to as the ‘Working Capital Ratio’ and is commonly used to gauge the short-term health of an organization. The larger the percentage, the more likely the company can pay its current liabilities.

Quick Ratio = Quick Assets (cash + accounts receivable) / Current Liabilities. The quick ratio is commonly known as the ‘Acid Test Ratio.’ It is a more conservative measure because it doesn’t include all assets used in the current ratio. It focuses on a company’s more liquid assets.

Debt to Equity = Total Liabilities / Shareholder Equity. The debt to equity ratio provides information on a corporation’s use of debt or financial leverage. Some debt is considered wise because interest is often tax deductible, can be less expensive than issuing additional shares, and allows the acquisition of assets without diluting the stockholder’s ownership interest. However, too much debt can be risky since the corporation may not be able to obtain additional loans to cover the cost of unexpected problems.

This gives you an overview of the Balance Sheet Statement. Remember if you want to get stakeholder buy-in you need to be seen as a trusted advisor. And speaking the same language can help you be seen as credible which builds trust.

My overview of other financial statements can be found here.

The Income Statement: https://www.dhirubhai.net/pulse/understand-income-statement-build-trust-finance-dan-everett-d1zfc

The Cash Flow Statement: https://www.dhirubhai.net/pulse/understand-cash-flow-statement-build-trust-finance-dan-everett-my3fc