Analysis of balance sheet

Balance sheet is considered to be the statement showing the business position of any company, firm or business organization as on a particular date. When it comes to business position, it represents the assets owned by the firm and liabilities owed by the firm to others.

A similar definition can be given for profit and loss account of any firm. Profit and loss account is a statement showing the income earned and expenditure incurred by the firm during a particular period.

Of course, the period can be monthly, quarterly, half yearly or yearly. In many countries, as per statutory rules in force,  each firm has to publish the balance sheet and profit and loss account at least once a quarter.

When it comes to the financial statements namely; balance sheet and profit and loss account of any firm, the following are the interested parties who are willing to know the details: the owners of the firm called as shareholders or stakeholders; the creditors who have been providing the materials required by the firm on credit terms; the bankers who had granted limits to the firm or who are willing to provide financial assistance to the firms; the debtors who are the users of the products and services provided by the firm; the auditors and the government.

Nowadays, the balance sheets are either provided in account form or statement form. For the purpose of analysis of any balance sheet, the liabilities can be bifurcated into long term liabilities consisting of capital, reserves and long term borrowings and short term liabilities consisting of sundry creditors, overdraft availed from the bankers, advance payments received from the customers and any other provisions. The liabilities are substituted by the word namely; sources and similarly the assets are substituted by the words namely; applications or uses.

The long term uses consist of land, building, machinery, intangible assets, noncurrent assets and short term uses consist of cash balance held by the firm, balance held in the bank, sundry debtors, stock of goods and advance paid to the suppliers.

The analysis of any balance sheet is done using ratio analysis and the ratios are classified into liquidity ratios, profitability ratios and solvency ratios.

Current ratio and quick ratio or acid test ratio are classified into liquidity ratios. Debt equity ratio and debt service coverage ratio are called as solvency ratios.

Gross profit ratio, net profit ratio etc. are called as profitability ratios