Abalance sheet is a financial statement that reflects the financialstatus of business for a given fiscal year[ CITATION Wah13 l 1033 ].The balance sheet, also the statement of financial position, has avital importance not only to an organization, but to the keystakeholders such as creditors, debtors, shareholders, investors, thegovernment, and the general public among others. The informationcontained in a balance sheet entails assets, liabilities, andequity[ CITATION Azm16 l 1033 ].A company’s assets are the items owned and classified as eithercurrent or non-current. The current asset includes cash and inventoryamong other items that are easily converted into cash. On the otherhand, non-currentassets comprise of property, tools, land, and equipment. Liabilitiesare also categorized into current and non-current depending on theobligation period in which the company has to pay. Finally, equityrepresents the difference between a company’s assets andliabilities.
Importanceof a balance sheet
Abalance sheet is important for a company or a business owner becauseit shows the actual value and financial position of the firm, what itowns and what it owes[ CITATION Wah13 l 1033 ].The balance sheet helps the business owner arrange the firm’sfinances so as to maintain an appropriate ratio of the assets andliabilities. An organization has to sustain an asset to liabilityratio of less than 1:1 to maintain a healthy financial position[ CITATION Azm16 l 1033 ].It also provides crucial information about the current status of thebusiness thus the business owner can rectify any mistakes inadvance.
Additionally,the balance sheet is one of the vital documents required by financiallenders and banks in advancing a credit facility[ CITATION Wah13 l 1033 ].Current and potential investorsuse the balance sheet to conclude and evaluate their investmentreturns in the company[ CITATION Wah13 l 1033 ].A company with high amounts of cash assets insinuates growth andprosperity.
Financialratios are calculated evaluations of different financial statements.The mathematical relationships and comparisons of various financialstatements of accounts are crucial for the company, investors, andcreditors in understanding the performance of the company. Financialratios are the appropriate and widely used tools in measuring thefinancial position of a business. In some instances, they are used tocompare performance in different industries. Financial ratios arecalculated in all kinds of business large, small or medium firms.
Someof the commonly used financial ratios include
Liquidityratiosare used to assess the company’s capability to settle itsliabilities when due.
Current ratio= current asset/ current liabilities
Thehigher the current ratio the more favorable is the company.
Solvencyratiosare aimed at evaluating the ability of the firm to pay its long-termdebts
Equity ratio= total equity/ total assets
Afavorable equity ratio should be high.
Debt ratio= total liabilities/ total assets
Alower ratio is more favorable, and a debt ratio of .5 is consideredreasonable.
Efficiencyratiosare used to determine how better a company utilizes its assets tocreate income.
Working capital ratio= current assets/ current liabilities
Inthis analysis a ratio of 1 is considered fine. Less than one impliesthat the company is overburdened with liabilities.
Inventory turnover ratio= cost of goods sold/ average inventory
Thisratio shows how a company efficiently controls its merchandise.
Profitabilityratiosshows a company’s ability to generate income from its operations
Gross margin ratio=gross margin/ net sales
Ahigher ratio is favorable the company is converting its inventoryinto high profits.
Profit margin ratio= net income/ net sales
Itmeasures how much of the sales contribute to the total income
Return on equity ratio= net income/ shareholder’s equity
Itassess how a firm utilizes shareholder’s money to create profits
Azmat, N., & Lymer, A. (2016). Basic Accounting. London: Quercus.
Wahlen, J. M., Jones, J. P., & Pagach, D. (2013). Intermediate Accounting: Reporting and Analysis. Mason: Cengage Learning.