What Does a Strong Balance Sheet Look Like?

During our last CFA class, the facilitator asked a question that drew my attention back to how strong or weak a statement of financial position can be. He asked, ‘how can you tell if a statement of financial position is strong or weak”? Before we look into that question, we need to understand some basic terms. The balance sheet is one of the three fundamental financial statements and is key to both financial modeling and accounting. The balance sheet displays the company’s total assets and how the assets are financed, either through either debt or equity. It can also be referred to as a statement of net worth or a statement of financial position. The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity.

As such, the balance sheet is divided into two sides (or sections). The left side of the balance sheet outlines all of a company’s assets. On the right side, the balance sheet outlines the company’s liabilities and shareholders’ equity. The assets and liabilities are separated into two categories: current asset/liabilities and non-current (long-term) assets/liabilities. More liquid accounts, such as Inventory, Cash, and Trades Payables, are placed in the current section before illiquid accounts (or non-current) such as Plant, Property, and Equipment (PP&E) and Long-Term Debt.

We have already established the meaning of current and long term assets, liabilities and owners equity on a previous blog. Have we ever stopped to wonder what makes up a healthy balance sheet? Balance sheet depicts a company’s financial health. It records all your business’ assets and debts; therefore, it shows the ‘net worth’ of your business at any given time. Company with a strong balance sheet are more likely to survive economic downturns than a company with a poor balance sheet.

Balance sheet, also known the statement of financial position, provides a business snapshot of what your company owns and owes through the date listed- usually at the end of a financial year. Comparing to earlier balance sheets, your current balance sheet will reflect your company’s ability to collect and pay debts over time.

Therefore, it gives current and potential investors informed decisions about lending you resources. In addition, if you familiarize yourself with using financial ratios, the balance sheet can provide warning signs for you to solve before your business could get hit. Here are the following tips on how to improve your balance sheet. Firstly, look at the collection of your receivables; implement a more aggressive collection strategy to ensure you get paid in time. Secondly, whenever assets are not generating a healthy return, liquidate them. Conducting financial ratio is a great way to determine whether your business is using its assets effectively and you may want to look at leasing assets or outsourcing production rather than purchasing them. This could be the most cost-effective option, particularly for assets which date quickly such as those in the technology sector.

##To be continued

##EMBA 28