Understanding the Basics of Financial Statements: The Balance Sheet

One of the fundamental financial statements,'Balance Sheet'Let's find out what it is, why it's important, and how to read it.

What is a Balance Sheet?

A Balance Sheet (Statement of Financial Position) is a statement that shows a company's financial status at a specific point in time. In English, it is called a Balance Sheet, and it is also abbreviated as B/S.

It consists of three elements: assets, liabilities, and equity. Assets represent the tangible and intangible properties owned by the company, liabilities represent the company's debts that must be repaid, and equity is the remainder after subtracting liabilities from assets, representing the company's net assets. In other words, the balance sheet is an important document that allows you to understand the company's financial status at a glance.

In the balance sheet, the amount of each item is recorded as a total, and it is a principle to arrange assets and liabilities in order of liquidity. Through this, it is possible to evaluate the company's short-term repayment capacity and fund raising capacity.

Understanding the Components of the Balance Sheet

As explained earlier, the balance sheet is composed of three major components: assets, liabilities, and equity. Each component plays an important role in understanding the company's financial situation.

• Assets: It represents the tangible and intangible properties owned by the company, including cash, inventory, equipment, and real estate. Assets are resources expected to contribute to the company's future revenue generation.
• Liabilities: It represents the company's obligation to repay creditors. This includes bank loans, accounts payable, and trade payables. Liabilities represent the company's financial burden, and the due date and interest rate are specified.
• Equity: The remaining balance after deducting liabilities from assets, representing the company's net assets. In the case of a corporation, it represents the shareholders' stake and is also called owner's equity. Equity is an important indicator for evaluating the company's financial stability and long-term growth potential.

These components are closely related to each other, and through the balance sheet, it is possible to comprehensively understand the company's financial status.

Assets: Definition and Types

Assets refer to valuable resources owned by a company, both tangible and intangible, and are generally classified into the following categories:

• Current Assets: Assets that can be converted into cash within one year, including cash and cash equivalents, short-term investments, accounts receivable, and inventory. Current assets play an important role in evaluating a company's short-term funding ability and the performance of its operating activities.
• Non-current Assets: Assets that can be converted into cash after one year, including investment assets, property, plant, and equipment, intangible assets, and other non-current assets. Non-current assets are resources that contribute to a company's long-term revenue generation and growth and play an important role in evaluating a company's financial stability and long-term prospects.

For example, tangible assets such as buildings and machinery owned by a company contribute to generating profits by being used in the company's production activities, and investment assets such as financial products and stocks are assets invested with the expectation of future profits.

Liabilities:

Liabilities refer to the debts that a company must repay. Liabilities are one of the ways a company raises funds, and while it allows the company to secure the necessary funds, it also incurs burdens such as interest expenses.

They affect the company's financial status and business performance, so proactive management is required. To maintain an appropriate level of debt, it is necessary to manage the debt size and repayment schedule in a planned manner and secure sufficient funds to repay the debt.

To reduce the burden of interest expenses, it is necessary to manage credit ratings and negotiate loan terms. Excessive debt can worsen a company's financial status and lead to risks such as bankruptcy, so caution is required.

Equity

Equity represents a company's net assets and is calculated by subtracting liabilities from assets. It indicates the stake held by the company's owners (shareholders) and is one of the key factors that determine a company's financial stability and profitability.

It is mainly composed of share capital, capital surplus, and retained earnings. Share capital is the amount initially invested in the company, capital surplus is the amount additionally raised through share issuance or capital increase that is not classified as share capital, and retained earnings are the amount of profits earned through business activities that are not paid out as dividends and are retained internally.

Based on this, it is possible to analyze and evaluate the company's financial status and business performance, and it is also used to predict future cash flows and make investment decisions.

Balance Sheet Preparation Methods and Principles

The balance sheet is a statement that shows a company's financial status at a specific point in time, and it records assets on the debit side and liabilities and equity on the credit side. The preparation method follows the following principles:

• Principle of Classification: Assets, liabilities, and equity are shown separately.
• Principle of Total Amount: Assets, liabilities, and equity are recorded in total, and assets and liabilities are not offset.
• Principle of 1-Year Basis: Assets and liabilities are classified into current assets and non-current assets, and current liabilities and non-current liabilities based on a 1-year basis.
• Principle of Liquidity Ordering: Assets are arranged in order of liquidity.
• Principle of Reserve Classification: Equity is shown separately as share capital, capital surplus, and retained earnings.

Through this, it is possible to clearly understand the company's financial status and enhance the reliability and usefulness of accounting information.

Fundamentals of Balance Sheet Analysis: Assessing Financial Health through Ratio Analysis

One of the representative methods of analyzing the balance sheet is ratio analysis. Through this, it is possible to evaluate the financial health and stability of a company. The main ratios include the following:

• Current Ratio: The ratio of current assets to current liabilities, which is an indicator for evaluating a company's short-term debt repayment capacity. Generally, a ratio of 100% or more is considered favorable.
• Debt Ratio: The ratio of total liabilities to equity, which is an indicator for evaluating a company's long-term debt repayment capacity. The appropriate debt ratio varies depending on the industry and size of the company, and a ratio of 100% or less is usually considered appropriate.
• Times Interest Earned Ratio: The ratio of operating income to interest expense, which is an indicator for judging whether a company can sufficiently cover its interest expense. A ratio of 1 or more means that the company can generate profits even after paying interest expense, while a ratio of less than 1 means that it is difficult to pay interest expense.
• Quick Ratio: The ratio of liquid assets to current liabilities, which is a more stringent indicator for evaluating a company's short-term debt repayment capacity than the current ratio.

By analyzing these ratios, it is possible to evaluate a company's financial status more objectively.

Balance Sheet Usage Examples

The balance sheet provides useful information for both investors and managers. Let's look at each use case.

First, investors can understand a company's financial status and cash flow through the balance sheet. Based on this, they can evaluate the investment value of the company and decide whether to invest.

For example, by checking the size of a company's assets and liabilities in the balance sheet and analyzing their ratios, it is possible to evaluate the company's financial health. It is also possible to predict the future growth potential of the company by considering profitability indicators such as sales and operating income. In addition, by looking at the cash flow statement, it is possible to understand the company's cash inflows and outflows and use it as a reference for developing a funding plan.

From a manager's perspective, the balance sheet can be used to understand the company's financial status and establish management strategies based on this. It is also used to prepare budgets and evaluate performance. It allows for the reduction of unnecessary expenses and the promotion of efficient fund management. In addition, by reviewing the statement of changes in equity and notes, it is possible to comprehensively understand the company's financial situation.

Conclusion

Today, we have learned about the balance sheet, which can be said to be the most important part of the financial statements. Next time, we will take a closer look at the remaining items, such as the income statement and cash flow statement.