Why is a balance sheet important?
While a profit and loss account is considered the most important financial statement (because it shows the profit), the balance sheet can reveal other relevant information.
A business may seem to be profitable, but the balance sheet may indicate otherwise:
- Cash balance – if a business is making a profit, where is the money going?
- Accounts receivable – if these are high, is the business having problems with its customers paying?
- Accounts payable – a high balance may mean the business is struggling to find cash to pay its suppliers and employees
- Property, plant, and equipment – what assets does the company have, and how appropriate are they for the business operations?
- Loans – are these being paid off, or increasing?
- Equity – a negative result (liabilities exceed assets) can signal insolvency
Who uses balance sheets?
Anybody asking for a business’s profit and loss account will also want to see the balance sheet. They go hand-in-hand:
- The balance sheet may have more assets than liabilities, but how profitable is the business?
- The profit and loss account may show high profits, but why is there very little cash?
It’s now time to explore each of the elements included in a balance sheet. If you’re ready, head over here.