Balance Sheet Equation

It is a well accepted fact that the balance sheet of any business tells us about its financial strength. Investors always study the balance sheet before taking any decision about making investments in that particular company. The contents of a balance sheet are standard and internationally accepted and companies have to present it to the outside agencies as a financial statement. Let us know more about this concept.

Balance Sheet Details

The balance sheet of any company will give you details about its assets, liabilities and total shareholder's equity. The assets can be of two types - current assets and fixed assets. The assets held by the company such as cash and cash equivalents, inventory, accounts receivable etc are included in the current assets column. The fixed assets of the company would be the plant and machinery which it owns, land, properties along with the intangible assets. The sum of the current assets and fixed assets will give you the total assets held by the company. The assets which get ultimately converted into cash within a period of one year are known a current assets in the balance sheet. On the other hand, fixed assets have a life of more than a year. Assets are subject to depreciation and it is subtracted from their value by following the basic accounting principles.

Then, the next column in the balance sheet is that of the liabilities. These are the obligations of the company to other companies, banks or institutions which need to be completed as soon as possible. Lesser the burden of liabilities, more self sufficient and prosperous the firm would be. The liabilities side mainly consists of accounts payable, taxes to be paid by the firm, and the long term bonds issued by the firm. Bonds are the loans granted by investors to corporations and hence they are included in the liabilities side of the balance sheet of the company. Whenever an individual purchases a bond, he has advanced the money to the company for its expansion policies and he is supposed to be paid fixed returns per year by the company. The sum of all these individual liabilities will give you the total liabilities before a firm.

From the above explanation, we know how to find out the total assets and liabilities of any firm. The balance sheet equation makes use of the assets, liabilities and the shareholder's equity and helps us to find any of these easily.

Assets = Liabilities + Shareholders' Equity.

Thus, if you wish to calculate the shareholder's equity in a company, you will have to subtract the liabilities of the company from the assets held by it in a specific period of time. You must remember that the shareholder's equity consists of the common stock as well as the retained earnings of the company. Retained earnings are those earnings or profits which are preserved by the company for a long time, These earnings will remain in the balance sheet of the company and are not given out to the shareholders of the company in the form of dividends. This money can be utilized by the company for its aggressive expansion policies to achieve steady and fast growth.

Hopefully, this article must have cleared most of your doubts and will help you to analyze the financial strength of firms before investing. So, start your calculations and invest in the right companies for getting decent returns over the years. Happy investing!