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How to Read a Balance Sheet

The balance sheet is one of the primary components of a set of financial statements. It discloses the assets, liabilities and shareholders' equity of the company as of a particular date which is usually the company's fiscal year-end date. The assets are divided between current and fixed, and the liabilities are divided between current and long-term. The shareholders' equity normally discloses the issued capital stock and the retained earnings. The current assets are those that are normally less than one year in duration, including cash, accounts receivable and inventory. The accounts receivable should not be outstanding for more than a year, and the inventory should not normally be held for that long either, before being sold. Fixed assets include items like land, buildings, furniture and equipment. Except for land, these items are depreciated over their useful lives and therefore show a net book value which declines over a period of years. Current liabilities are expected to be paid within one year, and include accounts payable, loans payable and taxes payable. Long-term liabilities are expected to be paid over a period longer than one year, but the short-term portion which will be paid within one year is disclosed in the current liabilities section of the balance sheet, with the remaining portion disclosed in the long-term section. In the shareholders' equity section, the various categories of issued capital stock are disclosed, including common and preferred shares. Authorized capital stock is also disclosed. Retained earnings represent the accumulated profits and losses of the company since its inception. This item is also contained within the shareholders' equity section of the balance sheet, and discloses the opening balance of retained earnings, the current year profit or loss after taxes, and the closing balance of retained earnings.

The balance sheet also contains a comparative column which discloses the amounts outstanding for all of the above categories as of one year prior to the financial statement date. The purpose of this is so that the reader can consider and ask questions as to what has transpired since last year in each of the key areas of the company. For example, if the current liabilities have increased by 60% since the prior year, the reader might want to investigate why this has happened.

If not an audited balance sheet, the title of the balance sheet will disclose whether it is a Notice to Reader or Review Engagement, so that the reader will understand the level of depth that the Chartered Accountant has undertaken in the preparation of the financial statements. In each of these three cases, the reader will be able to read either the Notice to Reader report, the Review Engagement Report or the Audit Report which is a separate page within the financial statements and explains the basis of preparation of the financial statements.

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How to Read a Balance Sheet | Simkover and Associates Chartered Accountants

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