One of the most important indicators of a company's financial position is the balance sheet. The balance sheet shows the current balances of the recorded assets, liabilities, and equity of an organization. Assets are the resources that the company owns or controls, such as cash, inventory, property, plant, and equipment. Liabilities are the obligations that the company owes to others, such as accounts payable, loans, and bonds. Equity is the difference between assets and liabilities, and represents the owners' claim on the company's net worth.
The balance sheet can be used to analyse the liquidity, solvency, and efficiency of a company. Liquidity refers to the ability of a company to meet its short-term obligations with its current assets. Solvency refers to the ability of a company to meet its long-term obligations with its long-term assets. Efficiency refers to the optimal use of resources to generate income and value.
One way to measure liquidity is to compare current assets and current liabilities. Current assets are those that can be converted into cash within one year, such as cash, marketable securities, accounts receivable, and inventory. Current liabilities are those that are due within one year, such as accounts payable, short-term loans, and accrued expenses. The excess of current assets over current liabilities means the availability of financial resources to expand the activities of the company. However, a significant excess indicates an inefficient use of resources. As a result, a significant excess of short-term assets over long-term assets maintained over a long period of time may be a sign of poor financial health of the company.
Another way to measure solvency is to compare long-term assets and long-term liabilities. Long-term assets are those that have a useful life of more than one year, such as property, plant, and equipment, intangible assets, and investments. Long-term liabilities are those that are due after one year, such as long-term loans, bonds payable, and deferred taxes. The excess of long-term assets over long-term liabilities means the ability of the company to generate income and value from its investments and operations. However, a significant deficiency indicates a high risk of default or bankruptcy. The case of a significant excess of the company's long-term liabilities over its long term assets means bankruptcy or pre-bankruptcy.
The balance sheet can also be used to calculate ratios that reflect the liquidity, solvency, and efficiency of a company. Some common ratios are:
- Current ratio: current assets / current liabilities
- Quick ratio: (current assets - inventory) / current liabilities
- Debt-to-equity ratio: total liabilities / total equity
- Asset turnover ratio: sales / total assets
- Return on assets: net income / total assets
- Return on equity: net income / total equity
These ratios can be compared with industry averages or benchmarks to evaluate the performance and position of a company.