Basics of how to prepare a balance sheet
Regardless of the type of business or industry it is for, every balance sheet is divided into three main parts:
- Assets – Assets are anything that have value. A dollar value is assigned to everything a company owns and it is recorded on the asset side of the balance sheet.
- Liabilities – Anything that costs a company money is a liability. Monthly rent payments, utility bills, a mortgage, corporate credit card debt and anything else a company has to pay is a liability, and is recorded on the liability side of the balance sheet.
- Shareholder equity – The difference between assets and liability is the shareholder equity. This is the “book value” of a company which is what is left for shareholders after all debt is paid.
The total value of all assets on a balance sheet must be equal to the combined value of the all liabilities and shareholder equity on the sheet. How to analyze a balance sheet depends on what it is you wish to determine.
How to analyze a balance sheet
A variety of different formulas can be used for analyzing a balance sheet equation. The following are some methods on how to analyze a balance sheet using different balance sheet ratios:
- Solvency ratios – Analysis of ability to pay short term debt.
- Quick Ratio = (Current Assets – Inventories) / Current Liabilities
- Current Ratio = Current Assets / Current Liabilities
- Debt-equity ratios – Analysis of how growth is being financed. Provides information on financial strength.
- Total Debt/Equity Ratio = Total Liabilities / Shareholders Equity
- Long Term Debt/Equity Ratio = Long Term Debt / Shareholders Equity
- Short Term Debt/Equity Ratio = Short Term Debt / Shareholders Equity
- Activity ratios – Measures a company’s ability to convert assets balance sheet into cash or sales and shows how efficient and well run a company is.
- Days Sales Outstanding = (Receivables / Revenue) x 365
- Days Inventory Outstanding = (Inventory / COGS) x 365
- Days Payable Outstanding = (Accounts Payable / COGS) x 365
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