What are the different types of balance sheets?
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There are three different types of balance sheets namely: Comparative Balance Sheet, Vertical Balance Sheet and Horizontal Balance Sheet.
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Understanding the market movements is a skill developed over years of trading in the stock market. However, as a beginner in the Indian stock market, you must understand the technical terms revolving around financial statements.
In this article, we will talk in detail about a Balance Sheet, its components, its importance and everything else you need to know.
The balance sheet is the key component of financial statements reflecting cash flow, profit and loss. Looking at the balance sheet, you can easily tell the financial status of a company as it features what the company owns and owes in terms of liabilities and assets.
A balance sheet is the summary of a company’s financial status in every financial year.
Now that you have a fundamental understanding of the balance sheet, let’s move ahead with its importance:
Reflects the Company’s Financial Health
A balance sheet showcases every detail about the company in terms of its financial health. Liabilities, assets and securities are all represented through the balance sheet.
Help Investors Make Informed Decisions
Investors and traders need to know about a company's financial health before investing money. Evaluating the balance sheet can provide a detailed insight into the company’s performance, analyse potential growth and make an informed decision.
To get a better hold of the balance sheet, you must understand the features of a balance sheet like assets, liabilities and equity.
Assets represent the company’s resources including tangible and intangible resources. These are then divided into two types: Current Assets and Noncurrent Assets.
Current assets reflect the company’s resources that can immediately be converted to meet immediate needs. Cash, inventory, and short-term investments come under current assets.
Non-current assets reflect those assets that the company uses for production, manufacturing or overall revenue generation. For instance- Setting up a factory, installing heavy machines are non-current assets.
Liabilities reflect the company’s obligation to pay shareholders, lenders etc. The simplest way to understand liabilities is this formula: Liabilities = Assets Company’s Obligations to Pay.
A company has current liabilities in the form of obligations that have to be fulfilled within one year like dividends, salaries, tax etc.
Non-current liabilities are in the form of long-term obligations like loans, bonds payable etc.
As the name suggests, total liabilities are the accumulated liabilities of a company’s short-term, long-term and other liabilities.
Shareholder’s equity reflects the company’s total assets minus the liabilities. It also reflects the company’s obligation to pay its shareholders at the time of winding up.
In addition to the above-discussed components of a balance sheet, knowing a few other terms can help you:
Assets that are tangible and the company owns for the long run like land, machinery etc are fixed assets
Assets that do not come under current or noncurrent assets.
The total number of assets that a company owns including its non-current, current and other assets.
Gross block is the actual amount hay the company paid to purchase an asset or the value of an asset before depreciation
Depreciation is the cost a company allocates for an asset in a year. Accumulated depreciation is the total cost charged on the asset to date.
Equity capital is the asset that belongs to the owner after clearing all forms of liabilities and obligations.
Reserves refer to the funds that the company keeps aside for future needs like expansion, clearing debts, repaying shareholders etc.
Funds or assets that the company has borrowed from financial institutions like banks or bondholders.
Contingent liabilities are those liabilities that the company may have to face during an uncertain event like a lawsuit or settlement.
The costs incurred by the company for any long-term work-in-progress activity are called Capital Work in Progress.
The fund a company has put in for developmental activities like purchasing land, machines or building digital infrastructure.
Shareholders who hold less than 50% of the company’s total share or voting rights are said to have a minority interest in the company.
Traders have been gauging the balance sheet of companies before they enter with their huge pockets. Here’s how
Analysing Ratios and Metrics
Liquidity ratios and metrics help an investor evaluate the company’s capability to repay its short-term liabilities. It reflects the company’s status to quickly convert its assets to meet immediate needs.
Solvency ratios reflect the company’s capability to meet its long-term needs.
As the name suggests, the efficiency ratio is used to determine the company’s capability to smartly use its assets and liabilities.
Traders often compare the balance sheets of a company over time i.e. at two different points. This showcases the company’s financial health and growth over two or more fiscal years.
Now that we have established that the balance sheet represents a company’s financial health, it is obvious that traders rely on the balance sheet to predict their stock performance.
A balance sheet is an important feature representing the financial statement of a company. As an investor, you should be able to understand and analyse the balance sheet to make an informed decision before you put your money in a company. However, remember that relying solely on the balance sheet is not an ideal move, you should keep an eye on market trends and charts, as well.
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There are three different types of balance sheets namely: Comparative Balance Sheet, Vertical Balance Sheet and Horizontal Balance Sheet.
The main components of a balance sheet are assets, liabilities and equity.
A balance sheet includes all types of assets and liabilities of a company representing the final financial statement.
The balance sheet formula is Assets = Liabilities + Equity.
A balance sheet is curated by the company’s owner or bookkeeper.
Balance sheet plays a significant role in the stock market as it helps investors to analyse the company’s financial health by looking at its assets and liabilities.
Yes, the Companies Act 2013 mandates every company to publish balance sheets.
The three main limitations of a balance sheet are the omission of valuable non-monetary assets, assets recorded at past cost and the use of estimates.
Fundamental analysis of the stock market refers to the analysis of the intrinsic value of a stock i.s analysing its financial statement, and external influences like industry trends and events.
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