The importance of the Accounting Balance Sheet

When you own your own company it becomes priority to concentrate on the accounting department, thus ensuring they produce statements of the financial and economic matters of your own company that will make a good impression on investors.  Therefore income statements should be impressive;   it is the income statement that will perform on your behalf.  Although the accounting balance sheet will be beside the question, it is the accounting balance sheets that indicate progress, declines and the financial health of a company.

In essence, the accounting balance sheet is a document that records every detail of the company’s financial position.  It is a statement consisting of two columns.  In the one column it gives you a list of the company’s assets - everything the business owns.  In the other column it shows the liabilities - the amounts of money or services owed to other individuals or companies.  When a professional accountant scrutinizes these columns, he sees more than the ignorant man on the street will see.

An accomplished accountant will firstly take a look at the columns on an accounting balance sheet to determine how healthy the business is.  He will try to determine the liquidity and solvency of the company.  Many people think that these two words are just synonyms.  In fact, although the two terms refer to how a company will be able to deal with the money it owes to other companies and individuals, there is a difference between the two words.

Liquidity involves the promptness with which a company will be able to pay their debts, or how the company will take care of immediate obligations.  Solvency applies to how well the company is able to pay debts that have to be paid off over years.  When the competent accountant studies a balance sheet, he also determines the coverage ratio.  The coverage ratio refers the amount of cash flow available to meet annual interests and expenses satisfactorily over a longer time.   The current ratio measures a company’s ability to pay short-term obligations.  Usually, in the short term, a company must earn twice more money than it owes to all its debtors.  Having this ability will be considered favorably by a bank when a business man approaches the bank for a loan.

A vertical and horizontal analysis can also be recognized on a balance sheet.  A vertical or common size analysis indicates every income statement amount as a percentage.  This enables the owner of the business or the accountant to compare the company’s income statement to another company’s, or to the industry average.  One can also see how the company measures up against the total assets or liabilities that the business has.  Then, the accountant can also have a look at the horizontal or trend analysis which indicates amounts on the financial statements over the past years.  This allows you the see how each item has changed in relationship to the changes in other items.