We live in a system in which market forces determine everything, from a government’s social welfare measures to a company’s accounting standards. And the intermittent but gradual deregulation of sectors of Indian economy means that more and more sections of the population are likely to be rendered open to the effects of corporate behaviour. Taking into consideration the fact that the Securities and Exchange Board of India (SBEI) has practical limits to its jurisdiction and more often than not is forced to strike deals with errand companies who manipulate market money flow and balance sheets, it is absolutely essential for investors to understand the potential risks of investing in the share market.
Often companies, especially the big corporate houses, succeed in misleading governmental oversight machinery and the shareholders about the companies’ financial status. It has repeatedly been experienced in the past that corporate honchos manipulate and falsify their balance sheets in order to attract large amounts of investments in the share markets. An eye opening example of this immoral trend is the Sathyam scandal which was of a mind boggling proportion- Rs. 7000 Crore. Unfortunately, in India, the nexus between the Corporates, politicians and the civil servants is so nefariously deep rooted and tightly bound that it becomes impossible for regulatory institutions to ensure even a semblance of transparency in financial accounting standards. Hence it is necessary for investors, whether big or small, to learn to read and understand the structure of balance sheets and learn the art of Balance Sheet Analysis.
Balance Sheet Analysis: A Brief Explanation
Balance sheet is often called ‘the snapshot of a company’s financial position’ at a particular point of time. In the field of financial accounting, ‘balance sheet’ is also called as the ‘Statement of financial position’. In actuality, it is a summary of the financial balances of an individually owned company/ business, a partnership enterprise or any specific publicly traded company. A standard structure balance sheet consists of 3 parts- the company’s assets, its liabilities and ownership equity or shareholder equity in the case of publicly traded companies. The foundational principle of a balance sheet is that the first part should equal the combined value of the second and third parts.
The equation can be viewed as-
Assets = liabilities + shareholders equity
Here the assets refer to the primary (financial) means on the basis of which a company or an enterprise operates. Liabilities are the financial obligations which are accumulated during the operation of the business and shareholders’ equity is the net asset or the capital of that particular company. The balance sheet, combined with a company’s income statement and cash flow statement, makes up the overall financial statement of that company. Hence it is absolutely essential for shareholders to learn the contours of balance sheet analysis in order to understand the financial position of their investment destination.
Balance Sheet Analysis: Advanced Aspects
Having a basic understanding of the more advanced constituents of the balance sheet might also come in handy in the task of balance sheet analysis. Important among the specifics of the assets are the ‘current assets’ and the ‘non current assets’. The former are those assets which can be converted relatively easily into hard cash. The current assets generally have a life span of one year or even less than that. This subcategory is further classified into- cash and its equivalents, accounts receivable, inventory, etc. Further, the non current assets include movable and immovable physical assets like land, machinery, buildings, etc. These assets are characteristically difficult to convert into hard cash within a single financial year, in effect, having a life span of a year or more than a year.
Liabilities are also of two types- current liabilities and long term liabilities. Long term liabilities are the debts which are due for payment after a period of one year or so. Current liabilities, on the other hand, are those financial obligations which must be paid off within a span of one year.
These specific concepts need to be understood correctly and in detail in order to complete the process of balance sheet analysis. Only after investors become conscious about such technical aspects of financial accountability of the corporate sector, that they will be able to ensure safe returns for their investments.