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The Balance Sheet: Definition, Elements, Significance, and Examination for Traders in the Stock Market

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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. 

Understanding the Balance Sheet

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. 

Importance of Balance Sheet

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. 

Components of Balance Sheet

To get a better hold of the balance sheet, you must understand the features of a balance sheet like assets, liabilities and equity. 

  • Assets

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:

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:

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:

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. 

  • Current Liabilities:

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:

Non-current liabilities are in the form of long-term obligations like loans, bonds payable etc. 

  • Total Liabilities:

As the name suggests, total liabilities are the accumulated liabilities of a company’s short-term, long-term and other liabilities.

  • Shareholders’ Equity:

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. 

Other Balance Sheet Terms that you Must be Aware of for Stock Analysis

In addition to the above-discussed components of a balance sheet, knowing a few other terms can help you: 

  • Fixed Assets:

Assets that are tangible and the company owns for the long run like land, machinery etc are fixed assets

  • Other Assets:

Assets that do not come under current or noncurrent assets. 

  • Total Assets:

The total number of assets that a company owns including its non-current, current and other assets. 

  • Gross Block:

Gross block is the actual amount hay the company paid to purchase an asset or the value of an asset before depreciation 

  • Accumulated 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:

Equity capital is the asset that belongs to the owner after clearing all forms of liabilities and obligations. 

  • Reserves:

Reserves refer to the funds that the company keeps aside for future needs like expansion, clearing debts, repaying shareholders etc.

  • Borrowings:

Funds or assets that the company has borrowed from financial institutions like banks or bondholders.

  • Contingent Liabilities:

Contingent liabilities are those liabilities that the company may have to face during an uncertain event like a lawsuit or settlement. 

  • Capital Work in Progress:

The costs incurred by the company for any long-term work-in-progress activity are called Capital Work in Progress. 

  • Investments:

The fund a company has put in for developmental activities like purchasing land, machines or building digital infrastructure. 

  • Minority Interest

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. 

How Traders Examine the Balance Sheet

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- 

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

Solvency ratios reflect the company’s capability to meet its long-term needs. 

  • Efficiency Ratios

As the name suggests, the efficiency ratio is used to determine the company’s capability to smartly use its assets and liabilities. 

  • Comparing Balance Sheets Over Time

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. 

  • Using Balance Sheet Data to Predict Stock Performance

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. 

Conclusion

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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Frequently Asked Questions

What are the different types of balance sheets?

Answer Field

There are three different types of balance sheets namely: Comparative Balance Sheet, Vertical Balance Sheet and Horizontal Balance Sheet.

What are the main components of a balance sheet?

Answer Field

The main components of a balance sheet are assets, liabilities and equity.

What is included in the balance sheet?

Answer Field

A balance sheet includes all types of assets and liabilities of a company representing the final financial statement. 

What is the balance sheet formula?

Answer Field

The balance sheet formula is Assets = Liabilities + Equity.

Who curates the balance sheet?

Answer Field

A balance sheet is curated by the company’s owner or bookkeeper.

What is the use of a balance sheet in the stock market?

Answer Field

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.

Is it mandatory for companies to publish balance sheets?

Answer Field

Yes, the Companies Act 2013 mandates every company to publish balance sheets.

What are the limitations of a balance sheet?

Answer Field

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. 

What do you mean by fundamental analysis of the stock market?

Answer Field

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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