Balance sheet is one of the most commonly used financial statements for performing financial analysis and comparative studies across companies and industries. Like most of the financial statements, balance sheet also has two sides. One side represents Assets held by a company and the other side represents the Liabilities of the company.
Balance sheet is used to study the financial condition of a company. By studying various components of a balance sheet, an analyst can obtain information on the financial standing of a company.
Balance sheet should be used in conjunction with other financial statements like profit and loss account in order to ascertain a true and fair picture on the financial state of affairs of any company.
Four Important Uses of Balance Sheet
Balance Sheet Helps in Assessing Liquidity and Solvency Position
Balance sheet provides an overall view on the funds (in the form of current assets) that a company holds. It also helps in knowing the amount of liabilities (in the form of current liabilities) that a business will be required to discharge in the near future. By comparing available funds against liabilities to be discharged, a company can judge its liquidity position.
By making an overall comparison of all assets against liabilities (short term and long term), a business can ascertain its solvency position. With a balance sheet, it becomes easier to understand the composition of various assets and liabilities without any need for the analyst to go into much detail.
Calculation of Ratios
With the help of balance sheet, many key ratios are calculated. Some of the important ratios are current ratio, quick ratio, debt equity ratio, debt to total assets ratio and so on. All these ratios are frequently used to comment on the financial status of the company.
A company can also obtain information on how frequently it is able to convert its debtors into cash with the help of accounts receivables turnover ratio. Similarly with the help of inventory turnover ratio, a company can come to know as to how frequently its inventory is converted into cash.
Useful for obtaining Loans and Funds
A balance sheet is frequently used as a basis for extending loans by banks and financial institutions. Without a balance sheet, it is almost impossible to obtain funds from sources outside the company. Moreover, investors may prefer to go through a company’s balance sheet before they decide to invest in the company.
A balance sheet may also be used to gain an understanding on the current status of business operations and also on expansion plans of the company. It also gives an understanding on the proportion of debt and equity in a company’s capital structure. Many times, investors are interested in knowing the shareholding pattern of a company.
Better preparation for Future Contingences
Information contained in a balance sheet can be used to ascertain the amount of funds that may be required in order to carry out various business processes. Any kind of contingencies can be prevented by regularly monitoring the balance sheet and its various components.