Balance Sheets - What are They and How are They Used?
How Business Acumen Applies to the Financial Statements:
Every publicly-traded company is required to file a comprehensive report about its financial performance every year, also known as a 10-K. This report has three financial statements you’ve probably heard of: the Income Statement, Statement of Cash Flows, and Balance Sheet. Below, we will be spotlighting the Balance Sheet.
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To understand the balance sheet, you must first understand its basic equation:
Assets = Liabilities + Equity
Assets are things that we own. This could include cash, investments, equipment, or machinery. We accumulate assets to drive economic value and benefit our company, therefore assets are seen as positives (+) on a balance sheet. There are two types of assets: current and non-current. Current assets typically include anything a company expects it will convert into cash within a year. Non-current assets are long-term investments expected to convert into cash after a year — or assets that aren’t easily converted to cash.
Liabilities are things that we owe. This includes our debts, bills we have yet to pay, or wages not yet paid to employees. Like assets, liabilities can be short-term or long-term.
Equity is the shareholder's value in the company or, in other words, their ownership in the business. Equity is sometimes referred to as net worth or book value. Going back to our original equation, assets (all of the resources a business owns) minus liabilities (all that is owed) equals equity (the residual leftover). This equation can leave the equity as either positive or negative. Positive equity means that assets exceed liabilities and a negative equity signals that liabilities exceed assets. Positive equity indicates that a company has good financial health. Decreasing net worth, on the other hand, signals a decrease in assets relative to liabilities and could be a sign of concern that companies can’t confidently repay their loans.
If there is a term you may not know you can visit our Financial Glossary Page. This will give you many business terms and often times an associated video.
What Your CEO Wants You to Know
If you aren’t an owner of a company, you may be asking “Why would I need to know this?” One reason is that it has been proven that a company does better when everyone is aligned to the same goals and objectives, but it can be difficult to align individuals across the business to the executives’ strategy.
When you better understand the balance sheet, your company’s financial position, and executives’ strategy, you can better understand where you can benefit the business. You can better predict the company’s needs and possibly rethink investments. Through communication and clear expectations, you can see the big picture and align everybody’s goals and strategies. Because every employee’s responsibility is to manage assets wisely to create value.
Getting the balance sheet right:
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