Interpreting Balance Sheets - Part - I

Please read why any company needs to be balanced here?

Any listed you observe releases a Balance sheet as a part of Annual Financial Statements.


A balance sheet is like a snapshot of time. It is affected by activities done in previous years like building acquired by the company in 2010 will come under assets owned by the company in the following years.


Balance = Assets = Liabilities + Equities

I have explained the above equation in detail here


Every company has its own accounting conventions and balance sheet line items. However certain basic line items are necessary according to company law'13.


Basic line items can be explained in a simple way. Let us start with the equities part.


Basically, there are two line items here - Share capital and Reserves and Surplus


Share Capital

It is the amount company receives by selling its shares to the public. This public includes other business entities, individuals etc. It is then subdivided into common stock and preference stock.

Common stock

You own the company to the extent of stocks you own in this company. Therefore you get voting rights in the company for electing the board of directors of a company. The company's profit is shared as a dividend to you. The Board of directors decides the dividend sum for you.

Preference stock

This is a special type of equity/stock because preferential shareholders are given preference treatment after debt but before common shareholders. The dividend will be at a fixed rate irrespective of profit. They don't get voting rights.

Note: It is one way of keeping debt and voting rights in control.


Reserves and Surplus

Since the balance sheet snapshot of time, it includes previous years' accumulated reserves and surplus. The company would calculate dividends considering that.


For example, A toy manufacturing company has gained a profit of Rs.1 lakh. The Board of directors decide to set aside 10% of net profit as a reserve and declared 20% as a dividend. Since it is a balance sheet it must have an opening balance, reserves opening balance is Rs.50000 and surplus opening balance is Rs.25000.


Closing Reserves = Opening balance + 10% of net profit = 50000 + 10000 = 60000

Dividend paid= 20% of net profit = 20000

Closing Surplus = Opening balance + (Net profit - Transfer to reserve - Dividend paid) = 25000 + (100000 - 10000 - 20000) = 95000

Reserves and Surplus as on date = Closing Reserves + Closing Surplus = 60000 + 95000 = 155000


Liabilities

It is then subdivided into - Current and Non-Current liabilities.Foe this purpose,we need to define what comes under Current and Non-Current.According to law,Non current is whatever that doesn't comes under current.Therfore it is essential to define what is current?



Source:Google


Current is defined in terms of Operating cycle and Balance sheet date.Operating cycle of a business varies from business to business.For example, some business may have 6 months and some can go up to 18 months etc.So whatever payment period less than operating cycle comes under Current liabilities.In terms of Balance sheet date,if the payment period is within 12 months from the date of balance sheet,it will come under Current liabilities.


Short term borrowings(T-bill,OD,CC etc) - Current liabilities

Long term borrowings(debts,bonds etc) - Non-Current liabilities

Trade payables - Current liabilities

Current maturity of Long term debts(i.e long term debts within 12 months) - Current liability


I think this gives you some intuitive idea about balance sheet.Next article we will see Assets.







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Disclaimer: This article is me speaking to me through this blog! Short Intro: If you want to innovate in a particular field, you need to understand how things work in the first place. Innovation is a