The Balance Sheet

.. asures the financial positions at a point in time. I think the arguments of the author are clear: if we assume that the current financial position can be described with the figures of the firms’ possessions and obligations, listed by types and amounts than we would have to agree that the balance sheet gives us this information. Obviously, being an indicator of the enterprises’ financial position, the balance sheet is a useful and powerful tool in the hands of managers, financial analysts and external users. Combined with the data on other financial statements it forms different ratios (like short-term liquidity ratios, short- and long- term solvency ratios, asset utilisation ratios and many others), which are the basis of each financial analysis. It is these data that can tell you if a company has enough money to continue to fund its own growth or whether it is going to have to take on debt, issue debt, or issue more stock in order to keep on keeping on.

Does a company have too much inventory? Is a company collecting money from its customers in a reasonable amount of time? Once again, it is the balance sheet – the listing of all of the assets and liabilities of a company – that can tell you all of this. And once again, its understanding is crucial for the management of the company, potential investors, and many other users. Now, having in mind all afore said, let us view another definition of the balance sheet: You can not have a more meaningless and confused statement holding a position of such a great importance (Keron Bhattacharaya, The accountancy’s faulty sums). Interesting opinion In order to find out this authors points of view we will have to consider the balance sheet restrictions and limitations and the needs of its users, or at least some of them. The balance sheet is in essence a list of the assets and liabilities of the enterprise or organization at a point of time. The fact that it represents the position at one point in time is itself a limitation as it is only relevant in that point of time.

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At any other time a new sheet has to be drawn up. This means that in order for the balance sheet to be useful it should be as up to date as possible, and that its utility diminishes the more out of date it becomes. Similarly, in order that it is an accurate measure of the assets and liabilities should be as up to date as possible, and here lies another limitation. Another very strong limitation of the balance sheet is the fact that the costs are given in their historical expression. Although, as prevoiusly stated, this has its reasons, still in some cases it blurs the information on the sheet. This is especially true applied to the accounting in high – inflation environment, and is probably one of the reasons for the opinion of the South Asian author – Keron Bhattaraya. But even in normal economics sometimes the assets being stated as a figure which bears little if any relation to the current value (the most obvious example of this in recent years has been the changes in prices and values of land and buildings).

This is a serious contradiction and recently there has been a trend showing assets in public accounts at a valuation rather than at a historical cost. Another short-coming of the balance sheet is its monetary expression. Little information can be drawn out of it on the enterprises’ activities, the profit of certain investments or managers’ decision, the success of new products, the company employees. It would be impossible however to show all of these in one-sheet summary. As I have early pointed the balance sheet itself is a contradictory document also because of the various needs of its numberous users and environments in which it is used. The activity in which the organization is involved can have dramatic effects on the classification of an asset.

What might not be an asset for one business would be an asset of another business, undertaking a different activity. Apart from these cases, which are to some extent reasonably clear cut, the activity can have dramatic effects on the difficulty or otherwise of drawing up a balance sheet. Consider for example the problems of a football club, trying to account for star players; or of a high technology business, trying to decide whether the cost of the patent on a new product is going to yield any future benefit when the state of the art is changing so rapidly. There are also issues related to the ways in which a business is perceived and the ways in which the management would wish the business to be perceived. For example a research has shown that the management, especially the management of smaller organizations, perceive that the bankers are interested in the amount of assets available as security for a loan or overdraft.

There is therefore a temptation to try to enhance the value of assets perhaps by revaluing the land and building prior to applying for a loan. Similarly in a number of cases where a business is in trouble the assets have been revalued in order to bolster the image of the business and to promote the impression of it having a sound asset base. In one word, what seems good and right to me, may not be enough for you. Still, there are many users to which the balance sheet does not seem confused and is necessary, although they have conflicting needs: IRS and other government and state institutions. It is probably fair to say that income statements are constructed with the IRS in mind more than any other user.

After all, it is the bottom line of the statements that determines what taxes will be due. Lenders are more interested in balance sheets, although the income statement is not taken lightly. The first question a lender must ask is What if this loan is not repaid? The lender will want something to sell to get paid back. A company’s balance sheet tells the lender what there is to sell. So a lender wants a balance sheet that indicates what the company owes (its liabilities) and what it owns (its assets). Assets include such obvious things as property and cash, but also accounts receivables (what the company is owed) and prepaid expenses (like advances on rent).

Things the company owes (accounts payable) include debt and bills yet to be paid, as well as what stockholders put into the business (stockholder equity) and retained earnings (profit not paid out to stockholders in the form of dividends or other payments). Lenders also want to look at the income statement, but they may be more interested in a cash statement. The IRS wants to know how much profit you make, but wants profits to be adjusted to account for depreciation (wear and tear) on assets the company owns. The lender finds that interesting, but the lender will not be comforted by the fact that the $1 million you spend on a new building will be depreciated over 10 years when the loan is for three. Finally, of course, shareholders want to look at income statements and balance sheets. They give snapshots of the current health of the business.

They may be less interested in any one period’s report than the trend. Are profits getting better? Is the balance sheet fatter? That’s because the share value does not have a simple relationship to either the balance sheet or the income statement. The value of a business is based on what someone would pay for it to gain control of the money it will make in the future. The balance sheet gives this potential buyer an idea of how easily the company can finance future growth and weather financial crises; the income statement gives the buyer an idea how much future profits might be. But an investor would need to know a lot of other things before coming to a decision about how much to pay. For people running the company, the financial statements are just a starting point.

The really interesting numbers may not show up on a statement, such as the profit margins on various products, projected sales, or order backlogs. The financial statements pull all these things together, but any analysis of how a company is doing needs a different kind of operational data. The best employee ownership companies share these numbers too. Now, having reviewed almost all the issues related with the balance sheet, we can say in my opinion that sine its appearance a few centuries ago it has been an important and outstanding financial statement summarizing the financial position of an enterprise at a particular point in time. In the quickly developing technological environemt it might change its form, it might even change some of its principles, it will be viewed along with more and more information in the era of information, but it will keep for some more time its position of such a great importance.

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