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Balance Sheet



Capital is the lifeline of any business and this is arranged by way of owner’s contribution (known as capital) and also through borrowings (known as debt). Funds so arranged by way of capital and debt are deployed in assets that generate revenue for the company and the Balance Sheet explains this in a precise manner. 

 

The Balance Sheet is a financial statement that reports an entity’s assets, liabilities, and owner’s capital at a specific point in time. It’s a    financial statement that provides a snapshot of what a company owns and owes. It gives a clear picture of sources of funds and where it’s used. Unlike Profit and Loss account, Balance Sheet provides information as on a particular date and not for a particular period. It’s an important source of information for fundamental analysis. But to be more effective it has to be used along with other financial statements like P&L a/c and cash flow statement. Also, being a statement on a particular date, it will be more useful when used with data for multiple years. Under Company’s Act also its mandatory for the companies to provide data for two years – for the current year as well as previous year (unless it’s a new company).

Preparation of Balance Sheet

Preparation of Balance Sheet is based on the following principle:

Assets = Liabilities + Capital

In the conventional style of Balance Sheet, popularly known as ‘T Statement’ liabilities and capital are shown on the left-hand side while assets are shown on right-hand side. Liabilities and capital are shown together because an organization cannot create its own funds and has to either borrow from creditors or the shareholders have to contribute as share capital. 

Format or Horizontal Format

Balance Sheet of ABC Company Ltd as on —-

Capital & Liabilities Rs Assets Rs
Capital & Reserves

Secured Loans

Unsecured Loans

Current Liabilities

Total

XXXX

XXXX

XXXX

XXXX

Fixed Assets

Investments

Current Assets, Loans & Advances

Miscellaneous Expenditure

Total

XXXX

XXXX

XXXX

XXXX

XXXX XXXX

Vertical Format

Balance Sheet of ABC Company Ltd as on —-

Assets Rs
Total Non-current Assets XXXX
Total Current Assets XXXX
Total Assets XXXX
Equity and Liabilities Rs
Total Equity XXXX
Liabilities
Total Non-current Liabilities XXXX
Total Current Liabilities XXXX
Total Liabilities XXXX
Total Equity and Liabilities XXXX

 

Thus, the assets side shows what a company owns, and the liabilities side shows what the company owes. Capital and Liabilities are also often called ‘Sources of Funds’ and Assets as ‘Uses of Funds.’ 

 

Using the data given in the first chapter, we can draft the Balance Sheet as follows:

 

Balance Sheet as on 31st March 2021 (Rs in Crores)

Capital & Liabilities Amount (Rs.) Amount (Rs.) Assets Amount (Rs.) Amount (Rs.)
Capital & Reserves     Fixed Assets    
    Equity Capital                     20       Land 16  
    Reserves                              64 84     Premises                      20  
Secured Loans   64     Plant & Machinery     47  
Unsecured Loans       Equipment                  1  
Current Liabilities         Computers                  1  
    Trade Payables                  26       Furniture & Fittings    2  
    Advance from Customers  1       Vehicles                        2  
    Other Liabilities                 17 44     Intangible Assets        6  
          Other Fixed Assets   1 96
        Less: Accumulated   depreciation   48
      Net Fixed Assets   48
      Investments  
      Current Assets, Loans & Advances    
          Inventories                          46  
          Trade Receivables              71  
          Cash equivalent                 10  
          Loans and Advances          11  
          Other Assets                         6 144
      Miscellaneous Expenditure  
           
Total   192 Total   192

 

Balance Sheet as on 31st March 2021 (Rs in Crores)

Assets Amount (Rs.) Amount (Rs.)
Total Noncurrent Assets    
    Land                             16  
    Premises                      20  
    Plant & Machinery     47  
    Equipment                   1  
    Computers                   1  
    Furniture & Fittings    2  
    Vehicles                        2  
    Intangible Assets        6  
    Other Fixed Assets    1 96
  Less: Accumulated    48
            Depreciation                  
Net Noncurrent assets   48
      Investments                                 0
     
Total Current Assets    
    Inventories                          46  
    Trade Receivables             71  
    Cash equivalent                 10  
    Loans and Advances          11  
    Other Assets                        6 144
Total Assets   192
Equity and Liabilities
Equity Amount (Rs.) Amount (Rs.)
    Equity Capital                    20  
    Reserves                              64 84
Liabilities    
Noncurrent Liabilities    
    Trade Payables                  26  
    Advance from Customers   1  
    Other Liabilities                 17 44
Total Liabilities   108
Total Equity and Liabilities   192

Assets

Funds are used/invested to acquire assets and such assets can be either current or noncurrent. Current assets are those that the business has acquired over a period of time and will be used or converted into cash within next 12 months. Prepaid expenses, account receivables, advance payments, inventories and bank balance are some of the examples of current assets. Noncurrent assets are usually fixed assets (meant for own use and not for resale) like land and building, equipment, furniture and long-term investments. 

 

In the above example, the total noncurrent assets of the company are Rs 96 crore which is the original cost of the assets bought and is also known as ‘Gross Block’. However, in the Balance Sheet fixed assets like land, building, premises and furniture are shown at the current value which is arrived at after deducting the accumulated depreciation. This is also known as Net Block. Current assets, on the other hand, are the result of company’s day to day operations and are part of its working capital. 

Liabilities

Similarly, liabilities also can be classified as current and noncurrent liabilities. Current liabilities are those which have to be paid within 12 months from the date of Balance Sheet. Accounts payable, utility bills payable, regular expenses (like salary, rent, insurance, etc.) payable, etc are some of the examples of current liabilities. Noncurrent liabilities are those ones which are not falling due for payment in next one year (from the date of Balance Sheet). Bonds, debenture and term loans are some of the examples of noncurrent liabilities. Usually, fixed assets are bought out of shareholders’ funds and long-term borrowings, i.e., noncurrent assets. If the company depends upon short term funds to acquire long term assets, say plant and machinery, that is considered as fundamental weakness of the company. 

 

In the above example, the company has Rs 64 crore noncurrent assets whereas its noncurrent assets are much less than this amount which indicates that the company is financially sound. 

Capital

Capital contributed by the owner (shareholder, in case of company) is the main source of funds for the entity. In case of company, it’s called equity capital and such capital carries voting rights at the general body meeting of the company. Alternatively, capital can also be contributed by way of preference share capital wherein the shareholder doesn’t get any voting rights but gets preference while paying dividend and repayment of capital. It should be noted that accumulated profits of the company that remain after paying dividend also forms part of the capital.

 

In the above example, capital contribution by the shareholders, initial and subsequent, is Rs 20 crore. Further, the company also has Rs 64 crore in reserves which is accumulated profits, capital reserves, premium on shares, etc. which is also considered part of shareholders’ funds.

How to read a Balance Sheet

To understand the contents of a Balance Sheet, you should always read it along with the schedules/notes which give details of every item appearing on the Balance Sheet. 

Fundamental Analysis

 

Given above is the extract of financial statements of a vehicle manufacturer wherein you can see a Balance Sheet on the left-hand side and some of the notes to Balance Sheet on the right-hand side. In the Balance Sheet, for every individual item, ‘Note No’ along with the page on which it is appearing is also given. These notes are nothing but further bifurcation/sub-classification and explanation of various items appearing on the Balance Sheet. For example, if you want to see details under Assets – Non-current assets – Financial assets – Loans, you have to refer to corresponding notes no which is 7 appearing on page 226. In the Notes no. 7 further details of loans are given as shown on the right side in the above image. Similarly, you can find out details for other items too by referring to the corresponding Notes no. In many annual reports you may not get to see the corresponding page nos and you may have to find out on your own by turning the pages based on note nos.

What to see in the Balance Sheet?

Of course, many indications may be obtained through ratio analysis which is discussed separately. Apart from that you can also find out many other details which may help you in your analysis. Generally, you need to focus on the following:

Item Head What to see in Notes
Property, Plant and Equipment and Other Intangible Assets In case of companies using natural resources like cement and metals you should see the Mining Reserves of the company to know whether the company has enough reserves for foreseeable future.
Related Party Transactions Increasing volume of business with certain related parties may have to be looked into in detail. 
Investments Market value of quoted investments to know whether they are more or less than the acquired cost and their impact on overall health of the company.
Investments Unquoted Investments – Whether the company is investing in unrelated business and other activities.
Inventories Any change in the method of valuation and any substantial write downs in the value of inventories
Cash & Cash equivalents If the company has substantial portion of its assets under this head for substantially longer period, it may indicate company doesn’t have enough expansion opportunities or the company is looking for inorganic growth opportunities.  
Issued, Subscribed and Paid up capital Aggregate number of equity shares issued as bonus, shares during the period of five years immediately preceding the reporting date – This indicates how liberal or otherwise the company is in rewarding the shareholders
Non-current borrowings Whether the rate of interest on secured loans compares favourably with prevailing rates.
Other Current Liabilities – Advance from customers This is useful especially in case of construction companies as the advance amount indicates the contracts to be executed in the near future.

Above list is just to show how the Balance Sheet can be used for our analysis. You will come to know more and more such items as you gain experience in financial statement analysis. 

Importance of Balance Sheet

Balance Sheet is essential to know the general health of the entity, its creditworthiness and its liquidity status. Indeed, analysing Balance Sheet in isolation may give incomplete and often misleading picture and therefore it should always be read along with auditor’s report (for any adverse remarks), profit and loss account (to know the present performance of the entity), schedules and notes on account. Also, it should be ensured that there are no material changes in company’s accounting policy and if there are any changes in the policy its impact on the Balance Sheet (and other financial statements) should be studied, without which analysis will be incomplete and inaccurate.   

 

The Balance Sheet gives enough indications about the health of the business. Whether the business is more dependent on borrowed funds or own funds can be found out from Balance Sheet. In the former case it’s a clear indication that the business is on the way to become bankrupt.  

 

Whether the customers of the company are taking longer time to pay? How efficiently debt is being collected by the company? Is the company taking longer time in paying creditors? Is the company overstocked or understocked? Answers to all these questions can be found out from the careful reading of the Balance Sheet. 

 

However, in the Balance Sheet assets are recorded at historical cost which may not represent its true present value. As a result, comparison of two companies formed in two different years becomes difficult and misleading. Further, many items that are of financial value but cannot be recorded objectively are not considered while preparing Balance Sheet. For example, in many organisations, especially in service industry, human resource plays a major role (than machinery) but Balance Sheet fails to record this asset. 

 

Despite these lacunae, Balance Sheet is a formidable source of information without which fundamental analysis would be incomplete. It’s the best source that gives interested parties an idea of the company’s financial position

Frequently Asked Questions (FAQs)

Why Balance Sheet is an important financial statement?

Balance Sheet is important because it reflects the net worth of an organisation by disclosing the amount the company owes and owns. Net worth of a company is the difference between what it owns (by way of assets) and what it owes to its creditors. 

 

What ratios are used to analyse Balance Sheet?

Several ratios like current ratio, quick ratio, working capital ratios, debt-to-equity ratio and solvency ratio can be used to analyse a Balance Sheet. These ratios reflect the liquidity, efficiency of working capital use, financial strength and solvency of the company.

  

Who are all have to sign the Balance Sheet?

Balance Sheet has to be signed by the auditors of the company, authorised signatories of the Board, Chief Financial Officer of the company and the Company Secretary.

 

Why a Balance Sheet is prepared as on a particular date?

Balance Sheet is prepared for a particular day rather than the entire period and under the Act, companies have to prepare it as on the last date of the financial year. The reason for preparing the Balance Sheet as on the last date of the financial year is that it reflects the ultimate impact of the operations of the company during the year on the health, liquidity and solvency of the company – whether the operations resulted in erosion or increase of the net worth of the company as at the end of the year. But remember that Balance Sheet has to be prepared as on the last date of Profit and Loss Account. Thus, if P&L A/C is for the year/period ending 31st January, 2022, then the date of Balance Sheet will have to be as on 31st January 2022 and it cannot be any other date. 

 




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