Significance of Balance Sheet

There is a popular myth that there a lot of basic concepts required to be understood and analyzed before analyzing the balance sheet. The truth is that balance sheet is derived from the basic working of the funds flowing the organization.

When a balance sheet is formed, it basically depicts how the money has come in the organization, what all are the aspects where the money is used, and how much money should be paid out too.
The company basically looks at the overall status and the position of its working year after year by having a look at the balance sheet.

As we saw, the balance sheet is basically divided in 'Liabilities' and 'Assets'.
The 'Liabilities' now can be segregated in two parts - Long term and short term.

The long term liabilities are the components from the area, from which the company has raised money for its operations. Hence it is called "Sources of funds". These sources of funds have two components "Equity" and "Debt".
Just to have a overall feel, "Equity" is the component wherein the company has raised money by issuing shares to the public. "Debt" is the component wherein the company has taken a loan or borrowed money for operations.

The short term liability by-and-large looks at the 'Current Liabilities'. Wherein there are current payments deliverable like creditors, bills payable, short term loans, etc.



Now at the Assets side, the Asset part is divided in 'Long Term Assets' and 'Short Term Assets'.

The 'Long Term Assets' comprise of Fixed Assets and Investments. These are the components which are directly or indirectly responsible for generating revenue and sales of the firm.

The 'Short Term Assets' are mostly the Currents Assets wherein the assets which are in hand or going to receive within one financial year.


Now the very basic analysis or significance of the balance sheet is -

The LONG TERM ASSETS should be able to suffice the LONG TERM LIABILITIES, and
The SHORT TERM ASSETS should be able to suffice the SHORT TERM LIABILITIES.

Hence this means that the company's operations are so strong that the current operation payables can be paid from the operating activity itself.
And the long term assets are so strong that they sufficient enough that the firm can payoff their long term liabilities.