How to analyse a Balance-sheet?

(This article explains the meanings of  current assets, fixed assets, intangible assets, share capital, reserve and surplus, long-term liabilities, current liabilities, contingent liabilities & assets.)

A balance sheet is a financial statement of an entity which is prepared for reporting of financial position of the business as at a particular date. The balance sheet is so called because the structure of the balance sheet is in the ‘T’ form with both the side of it equally balances [i.e. (Owner’s Equity+ Total outside liabilities at one side) = (Total Assets shown on the other side). Though there is no restriction to prepare a balance sheet ‘as at’ on any date, the Income Tax Act prescribes that all the business concerns must prepare their financial statements as on 31

A balance sheet is a financial statement of an entity which is prepared for reporting of financial position of the business as at a particular date. The balance sheet is so called because the structure of the balance sheet is in the ‘T’ form with both the side of it equally balances [i.e. (Owner’s Equity+ Total outside liabilities at one side) = (Total Assets shown on the other side). Though, there is no restriction to prepare a balance sheet ‘as at’ on any date, the Income Tax Act prescribes that all the business concerns must prepare their financial statements as on 31^st March of every year.

A corporate balance sheet as per Schedule VI of the companies act is in a concise format of 7 heads viz. Equity, Long-term liabilities, Current liabilities, contingent liabilities, Current assets, Fixed Assets (Long-term investments in property, plants, and equipment), and intangible assets. In this format, the comparison of the balance- sheet of a reporting period with previous years tells us the changes in the position of owner’s investment in the business year by year. It shows how the capital is distributed, how much of investment is identified with various accounts.

There is no standard format for balance sheets of non-corporate.Normally, we find the following 8 heads appearing on a balance sheet.

1. Share capital

The share capital comprises subscription of all kinds of shares like equity shares, redeemable and irredeemable preference shares. Since 1988, companies are permitted to issue redeemable and irredeemable shares with redemption period not exceeding 10 years. The redeemable and irredeemable shares with the redemption period of below 12 years from the date of the balance- sheet are treated by the banks as debt and not as equity. This is because the repayment obligation of the company is certain and time bound.

2. Reserve and Surplus

The Reserve and Surplus head in a balance sheet shows the amount separated from the profit of the business for some specific purposes like Revenue Reserve, General reserve, capital reserve etc. In the other words, the reserve and surplus are the retained profit of the business, not distributed as dividends. As per companies act, all kinds of reserves including Revaluation of properties, Reserve for tax, Reserve for Bad debts, Depreciation Reserves are considered as Reserve Fund.  However, banks classify the above items as ‘Provisions’ for known and certain liabilities and exclude them from equity, as there is no actual cash flow and they are only for the book entries. (To know in detail about reserves, provisions ,accounts payable and accruals click “the difference between reserves and provisions explained“)

3. Long-term liabilities

The Long-term liabilities are all liabilities other than current liabilities. The term loans availed by the firms from banks and financial institutions, for the purchase of plants and machinery, with longer repayment period (more than a year) or under deferred credits are examples of ‘Long-term liabilities’. Long term liabilities include debentures and bonds, due beyond a year. The borrowings from close friends and relatives of a proprietor or partners of a firm and acceptance of fixed deposits by reputed firms from retail investors are other examples of long-term liabilities. The debentures (not maturing within one year), Preference shares (redeemable after one year), Term loans (excluding installments payable within one year), Deferred Payment Credits (excluding installments due within one year), Term Deposits payable after one year, and other term liabilities are examples of long-term liabilities.

4. Current Liabilities:

The current liabilities are those dues, to be settled within 12 months from reporting date, including overdraft and loan installments payable within 12 months.  The facilities like Cash Credit, Overdraft, Packing credit, short term loans etc. availed from banks, the Creditors for the purchase of raw materials and consumable spares, Advance received from customers, Statutory liabilities, debentures maturing within one year, Preference shares redeemable within one year, Term loans installments payable within one year, Term Deposits accepted by the company maturing within one year etc. are the examples of current liabilities.

5. Contingent  liabilities

Arrears of cumulative dividends, Gratuity liability not- provided for, Disputed excise/customs /tax liabilities, Pending lawsuit (possibility of liability arises only on court judgment), and other liabilities not provided for are the examples of contingent liabilities.

A liability is called contingent liability or an asset is called contingent assets if that liability or the asset materializes only on the happening of a future event. A contingent liability or the asset is no liability or asset of an entity as of now, as neither the amount nor the liability/asset is certain. Thus, contingent liabilities or contingent assets refer to only the possibility of arising of a future liability or an asset on happening of the certain event.

6. Current Assets:

Current Asset is defined as ‘Any assets of a business organization that is expected to realise within 12 months from the reporting date or normal operating cycle which includes cash in hand and bank balance (including deposits maturing within one year). The inventories viz. raw materials, work- in- progress, finished goods, including those in transit, stores (coal, fuel, oil, lubricants, packing materials, labels etc., coming under stores.), are classified as current assets.

7. Fixed Assets

Fixed assets are tangible assets; usually referred as property viz. ‘plants and equipment’. The land and buildings, plant, machinery, motor vehicles, furniture, and fixture, are the examples of fixed Assets. The Fixed assets are normally not for sales and they are used for production or trade. The useful lives of the fixed assets are more than a year. Unlike current assets, the value of the fixed assets cannot be traced through the value of goods or services sold by the business enterprise. The valuation of fixed assets are made on the basis of their original cost and the value of each item is reduced every year by providing depreciation, taking into account of the useful life of the asset. The value of the fixed assets at cost is usually referred as ‘Gross Fixed Asset’ or ‘Gross Block’ and the amount of depreciation to date, as ‘Accumulated Depreciation’.  The Net value of the asset is usually referred to as ‘Net Fixed Asset’ or Net Block’.

8.Intangible assets

The assets which are in the form of physical substances are called tangible assets. Land, buildings, motor vehicles, furniture, inventories are few examples of tangible assets. The intangible assets are, any long-term assets useful to the business, but they do not have any physical dimension. The assets like the brand franchise, trade- mark, royalty, patent, copy -right, distribution right etc., which do not have physical substance are called intangible assets. The intangible assets; although do not have physical characteristics, they represent value, rights, privileges and economic benefits, just like tangible assets.

Information available in the balance sheet in accordance with Schedule VI of companies Act

Part I of the schedule VI to the companies act lays down the details of form and contents of the balance sheet. Part II specifies the requirement of Profit & Loss Account. The schedule VI of the act specifies large numbers of quantity and non-monetary information to be given and the following information are important parts of a financial statement. They are (a)  Contingent liabilities and other items, (b)Uncalled liability on partly paid shares,(c) Arrears fixed cumulative dividends, and (d) Estimated amount of contract remaining to be completed and not provided for.

Related article:How to study a profit and loss statement?