There is no doubt that any business, big or small has to find out where exactly they stay as their finances are concerned. All of us start businesses with the main objective of making decent profit and would be keen to show a bottom line which is healthy. Towards this objective having the right accounting principles and practices in place is of paramount importance. This will help to come out with a reliable profit and loss account and balance sheet. This is also referred to as final accounts. They could be considered as the bible when it comes to knowing more about the company and its overall financial performance and strength. If you are a person who would like to invest in stocks and shares, you must know how to read the final account properly. This will help you to find out the strengths and weaknesses of the company because the final accounts well and truly present a birds’ eye view of the company and its operations from various parameters. Over the next few lines we will try and have a look at a few tips which could help in deciphering the information that is contained in balance sheets.
There is no doubt that a company’s progress or regression cannot be understood property without the right balance sheet being in place. It is also known as a Statement of Financial Position. It is a report which shows information about the company’s assets and liabilities and also more about the net worth or equity of the company. This should be read in conjunction with income statement and cash flow statement to get a thorough picture at any given point of time.
Understanding the balance sheet equation is vital because it will give you a birds’ eye view of the total assets, which is nothing but liabilities and equity of shareholders. In other words the assets which are required for running the company must be adequately balanced by its obligations and liabilities. Understanding this equation is vital to give the right kind of picture about the company.
Current accounts are those which usually have a life span of around one year. In other words they can easily be converted into cash within short period of time. A few examples of current assets are accounts receivable, inventory, cash balance and bank balances. When we talk about current receivables, we are referring to short term obligations which are receivable from customers. There also should be
When reading a balance sheet one cannot afford to gather the right information that is emanating from non-current assets. These are assets which cannot be converted into cash easily. They could include fixed assets such as plant and machinery, properties and buildings, computers, land and buildings and quite a few other things. There could also be some other form of noncurrent assets in the form of patents, goodwill and copyright. Hence when reading a balance sheet, you must be sure that the company has a reasonably health percentage of non-current assets, vis-à-vis its total assets.
When running a business it is quite obvious that you will also be incurring some liabilities. They are nothing but financial obligations which the company owes to its vendors and other stakeholders. As is the case with assets, liabilities can be short term and long term. Overdrafts taken from banks could be a combination of both short and long term liabilities. Money which has to be paid to vendors and suppliers is also a part of short term liabilities. There should be a good mix of current and long term liabilities and the overall ratio between assets and liabilities should also be as per accepted norms.
The health of a company can be understood quite well if one knows how to study the shareholders’ equity. When a business is started the promoters invest money and run the business. After each year, when profits are made they are distributed amongst various stakeholders including shareholders. If there is surplus left it is transferred to a reserve account. Hence the higher the amount of reserves the better would be the health of the organization.
While cash and bank balances are good indicators about the cash flow position of the company, this alone should not be the yardstick to know more about the company and its financial strength. This could be found out from various other information sources such as the difference between current assets minus current liabilities and so on.
In a highly competitive business environment, only those organizations which have the right working capital available at all points of time would be able to turn in good results. The current assets should always be more than the current liabilities which means there is excess cash flow available at all point of time. The better the working capital ratio the healthier the organization ought to be.
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