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Vertical Balance Sheet

Published on :

21 Aug, 2024

Blog Author :

Edited by :

Reviewed by :

Dheeraj Vaidya

What Is Vertical Balance Sheet?

A Vertical Balance Sheet is the representation of a company’s assets, liabilities, and shareholder’s equity in a report format where all the items are listed from top to bottom in a single column. Also, the line of items under each category is shown in the descending order of their liquidity.

Hence, in such a vertical format, the items that take maximum time to liquidate are at the top, and the ones that liquidate quickly are at the bottom. Such presentation of the balance sheet items facilitates their internal comparison between two consecutive accounting periods and external comparison of business performance with that of other organizations within an industry.

Table of Contents

Vertical balance sheet explained, difference between vertical and horizontal balance sheet, frequently asked questions (faqs), recommended articles.

• A vertical balance sheet refers to a report format whereby the assets, liabilities, and equity are recorded in a single column, one below the other, in the order of the descending liquidity period of the items in their respective categories.
• The order of vertical format is non-current assets, current assets, non-current liabilities, current liabilities, and shareholders’ equity.
• The horizontal and vertical balance sheets are two different financial statement formats, where the former is generally a four-column report that represents the assets and liabilities line of items side by side, along with their respective amounts.

A vertical balance sheet is a single-column representation of all the assets, liabilities, and equity of an organization. In this accounting format, the balance sheet begins with a listing of assets, then liabilities and shareholders’ equity . Moreover, the recording of all these balance sheet items is done in the decreasing order of their liquidity tenure under their relevant categories. 

Given below are the three vertical balance sheet categories in their respective order:

• Assets : The asset category has two sub-heads: non-current assets and current assets . The balance sheet begins with the non-current assets having a maturity tenure of more than 1 year, such as fixed assets . It is followed by the current assets that are liquidated within a year, including inventories and cash.
• Liabilities : The subsequent reporting is of non-current and current liabilities. The non-current liabilities involve long-term obligations, which would be settled after a year. Then comes the current liabilities, which have to be fulfilled within 1 year, such as short-term borrowings and trade payables.
• Equity : This is the last section of this report format that represents the share capital, retained earnings , and other shareholders’ equity items.

The vertical format often provides a clear and quick overview of the firm’s financial position to the stakeholders, including the investors, shareholders, financiers, creditors , regulatory bodies, etc. It even facilitates immediate comparison between the line of items with similar liquidity or with the accounting records of other similar companies.

Moreover, it fosters transparency and aids in analyzing the current and future liquidity position of the business. However, such a representation is not helpful for trend analysis, as it fails to demonstrate the reports for different accounting periods. Also, it may not be suitable when there is an extensive list of balance sheet items.

The primary vertical balance sheet proforma states the assets first and then the liabilities and equity, while all the items listed are in the descending order of their liquidity position or tenure, as shown below:

However, the companies can modify this report format to include the accounting figures of the previous year in a separate amount column to facilitate the comparison of the company’s financial status over different accounting periods.

Let us find out the practical representation of assets, liabilities, and equity in this format with the help of the following examples:

Suppose the management of a budding firm, ABC Ltd. It is to protect the company’s performance in an investors’ meet where it is seeking a successful funding round . The business is in fair financial health and is majorly funded by the owner’s capital. It has limited external liabilities. Now, in the presentation, if the team uses a horizontal balance sheet, then the investors would find it difficult to compare the current assets with current liabilities . However, if they use a vertical balance sheet, then it becomes easy for the investors to identify at a glance that the company has a solid leverage position and its assets are majorly funded internally.

Suppose Company Alpha and Company Beta, both vying for investor attention, approach their annual shareholder meetings with differing balance sheet presentations. Company Alpha employs a horizontal balance sheet format, showcasing a spike in current assets due to increased inventory purchases ahead of an anticipated market demand surge.

However, this is met with a sharp rise in current liabilities, mainly driven by aggressive short-term borrowing to finance the inventory buildup. Meanwhile, Company Beta adopts a vertical balance sheet format, enabling investors to discern a similar surge in current assets but with a more stable current liabilities trend. The vertical layout indicates efficient working capital management and a cautious approach to financing, potentially positioning Company Beta more favorably in investors' eyes.

The vertical and horizontal balance sheets are two of the three different types of balance sheets. They differ in the following ways:

A user can analyze it by comparing items of similar liquidity, for example, comparing the current assets with the firm's current liabilities and fixed assets with the long-term debt of the company. Moreover, the analyst can gauge the current year’s change in assets, liabilities, and equity position when compared to that of the last year to interpret the company’s financial health.

It is a condensed form of accounting summary that facilitates a straightforward interpretation of the firm’s liquidity and leverage position. Also, it helps the stakeholders quickly compare the company’s internal financial soundness and liquidity with that of its competitors in the industry. Moreover, it helps to determine whether the assets are funded through equity or liabilities.

Such a report format can be efficiently used for demonstrating the company’s financial position at a glance during corporate meetings, presentations, and reports.

This article has been a guide to what is Vertical Balance Sheet. Here, we explain its format, examples, and comparison with horizontal balance sheet. You may also find some useful articles here –

• How to Read a Balance Sheet?
• Classified Balance Sheet
• Balance Sheet Reconciliation

Vertical Balance Sheets: Components, Analysis, and Financial Impact

Discover how vertical balance sheets enhance financial analysis, decision-making, and advanced interpretation techniques for better business insights.

Vertical balance sheets offer a streamlined approach to financial reporting, presenting assets, liabilities, and equity in a single column. This format simplifies the comparison of financial data across different periods or companies.

Understanding vertical balance sheets is crucial for stakeholders who need clear insights into an organization’s financial health. They facilitate easier analysis of financial ratios, which are essential for evaluating performance and making informed decisions.

Key Components of a Vertical Balance Sheet

A vertical balance sheet organizes financial data in a single column, making it easier to read and interpret. At the top of this column, you’ll typically find current assets, which include cash, accounts receivable, and inventory. These assets are expected to be converted into cash within a year, providing a snapshot of the company’s short-term financial health. For instance, a high level of accounts receivable might indicate strong sales but could also suggest potential collection issues.

Following current assets, non-current assets are listed. These include long-term investments, property, plant, and equipment (PP&E), and intangible assets like patents and trademarks. Non-current assets are crucial for understanding a company’s long-term investment strategy and operational capacity. For example, significant investment in PP&E might indicate a focus on expanding production capabilities, which could be a positive sign of growth.

Liabilities are presented next, starting with current liabilities such as accounts payable, short-term loans, and other obligations due within a year. These liabilities provide insight into the company’s short-term financial obligations and liquidity. A high level of current liabilities compared to current assets might raise concerns about the company’s ability to meet its short-term obligations.

Non-current liabilities follow, including long-term debt and other long-term obligations. These liabilities are essential for understanding the company’s long-term financial commitments and leverage. For instance, a high level of long-term debt might indicate potential risks but could also suggest strategic investments in growth opportunities.

Equity, the final component, represents the owners’ residual interest in the company after liabilities are deducted from assets. This section includes common stock, retained earnings, and additional paid-in capital. Equity is a critical measure of the company’s financial stability and long-term viability. For example, growing retained earnings can signal a profitable and well-managed company.

Analyzing Financial Ratios Using Vertical Balance Sheets

Vertical balance sheets provide a streamlined format that enhances the analysis of financial ratios, offering a clear view of a company’s financial health. By presenting all financial data in a single column, it becomes easier to calculate and interpret various ratios that are fundamental to assessing performance. For instance, the current ratio, which is derived by dividing current assets by current liabilities, offers insights into a company’s liquidity. A higher current ratio suggests that the company can comfortably meet its short-term obligations, while a lower ratio might indicate potential liquidity issues.

Another important ratio is the debt-to-equity ratio, which compares a company’s total liabilities to its shareholders’ equity. This ratio helps in understanding the level of financial leverage and risk. A high debt-to-equity ratio might signal that a company is heavily reliant on debt to finance its operations, which could be risky if not managed properly. Conversely, a lower ratio indicates a more conservative approach to financing, relying more on equity than debt.

The vertical balance sheet also facilitates the calculation of the return on assets (ROA) ratio, which measures how efficiently a company is using its assets to generate profit. By dividing net income by total assets, stakeholders can gauge the effectiveness of the company’s asset utilization. A higher ROA indicates that the company is generating more profit per dollar of assets, reflecting efficient management and operational success.

Profitability ratios, such as the gross profit margin, are also easier to analyze using a vertical balance sheet. The gross profit margin, calculated by dividing gross profit by total revenue, provides insights into the company’s production efficiency and pricing strategy. A higher margin suggests that the company is effectively managing its production costs and pricing its products or services appropriately.

Impact on Financial Decision-Making

The vertical balance sheet’s streamlined format significantly influences financial decision-making by providing a clear and concise view of a company’s financial position. This clarity is particularly beneficial for stakeholders such as investors, creditors, and management, who rely on accurate and easily interpretable data to make informed decisions. For instance, investors can quickly assess the company’s liquidity and leverage, helping them determine the risk and potential return on their investment. The ease of comparing financial data across different periods or companies also aids in identifying trends and making strategic investment choices.

Management teams benefit from the vertical balance sheet by gaining a comprehensive understanding of the company’s financial health, which is crucial for strategic planning and operational decisions. For example, a clear view of current and non-current liabilities can help management decide whether to pursue additional financing or focus on reducing debt. Similarly, insights into asset composition can guide decisions on capital expenditures, such as whether to invest in new equipment or expand existing facilities. This holistic view enables management to align their strategies with the company’s financial capabilities and market conditions.

Creditors, on the other hand, use the vertical balance sheet to evaluate the creditworthiness of a company. By analyzing the balance sheet, they can assess the company’s ability to meet its short-term and long-term obligations. This assessment is critical for determining the terms of credit, such as interest rates and repayment schedules. A company with a strong balance sheet is more likely to secure favorable credit terms, which can enhance its financial flexibility and growth potential.

Advanced Techniques for Interpreting Vertical Balance Sheets

Interpreting vertical balance sheets can be taken to a more sophisticated level by employing advanced techniques that delve deeper into financial nuances. One such technique is trend analysis, which involves examining the balance sheet data over multiple periods to identify patterns and shifts. This approach can reveal underlying issues or opportunities that might not be apparent from a single period’s data. For instance, a consistent increase in inventory levels over several periods could indicate overproduction or declining sales, prompting further investigation.

Another advanced method is common-size analysis, where each line item on the balance sheet is expressed as a percentage of total assets. This technique allows for easier comparison across different companies or industries, regardless of size. By converting absolute numbers into relative terms, stakeholders can better understand the proportion of resources allocated to various asset categories and liabilities. For example, a company with a higher percentage of intangible assets compared to its peers might be more focused on innovation and intellectual property.

Scenario analysis is also a valuable tool for interpreting vertical balance sheets. This involves creating different financial scenarios based on varying assumptions about future conditions, such as changes in market demand or interest rates. By modeling these scenarios, companies can assess the potential impact on their balance sheet and make more informed strategic decisions. This proactive approach helps in preparing for uncertainties and mitigating risks.

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Balance sheet vertical analysis: what it is and how it works.

Oct 16, 2023 Stefan van Duyvendijk

Do you want to take your financial analysis skills to the next level and get more detailed insight into your financial statements? Learning how to perform a vertical balance sheet analysis can equip you with the skills to extract actionable insights into your company’s current financial health.

Vertical analysis provides a better understanding of how each line item on the balance sheet fits into the company’s financial structure and is an invaluable decision-making tool.

Read on to learn more about vertical analysis of a balance sheet, how to perform one, and some limitations and drawbacks of this analytical tool.

What Is a Vertical Analysis?

A vertical analysis, also known as common-size analysis, is a method of financial statement analysis that shows each line item as a percentage of a base figure within the statement.

So, in a vertical analysis of a balance sheet, every line item — cash, accounts receivable, fixed assets, accounts payable, stockholders equity , etc. — is shown as a percentage of total assets. In a vertical analysis of an income statement, every line item is shown as a percentage of gross sales.

This type of analysis enables businesses to view the relative proportions of account balances, compare internal changes over time, and identify trends. It’s an effective tool for comparing a company’s financials to those of competitors and an industry benchmark because it allows for easy, straightforward comparisons across different periods and companies of varying sizes.

Vertical Analysis Formula

The formula for vertical analysis is straightforward. You simply divide the figure for a specific line item by the total assets (for a balance sheet) or total sales (for an income statement) and then multiply the result by 100 to get a percentage. This formula can be expressed as:

Vertical Analysis Percentage = (Individual Line Item / Total Assets or Total Sales) * 100

Converting the raw numbers into percentages provides a clearer picture of the proportion of the asset or liability in the context of the company’s total financial resources.

Example of the Vertical Analysis Formula

Let’s look at an example to see how applying the vertical analysis formula might work in the real world.

Say Jackson Widget Company’s balance sheet shows the following amounts as of December 31, 2023:

• Cash: $100,000
• Accounts Receivable: $40,000
• Fixed Assets: $50,000
• Accounts Payable: $30,000
• Notes Payable: $10,000
• Capital Stock: $10,000
• Retained Earnings: $140,000

Based on the information above, Jackson Widget Company’s total assets are $190,000. That’s $100,000 in cash plus $40,000 in accounts receivable plus $50,000 of fixed assets.

So a vertical analysis would show Cash as 53% of total assets ($100,000 / $190,000) * 100 = 52.63%), accounts receivable as 21% of total assets ($40,000 / $190,000) * 100 = 21.05%), and so on.

How to Perform a Vertical Analysis on Your Balance Sheet

Performing a vertical analysis on your balance sheet is a strategic way to gain valuable insights about your business’s financial standing. By converting each line item into a percentage of total assets, you can uncover patterns, identify areas of strength and weakness, and make informed decisions about your company’s future. Here is a step-by-step guide on how to perform a vertical analysis on your balance sheet:

Step 1: Gather your balance sheet figures

First, gather the balance sheet figures for each line item, such as cash, accounts receivable, fixed assets, etc. You can likely export the company’s financial statements from your accounting software to an Excel spreadsheet for easy analysis.

Step 2: Identify total assets

The first step is to find the Total Assets figure on your balance sheet. This primary variant serves as the base figure for your vertical analysis.

Step 3: Calculate the percentage for each line item

For each line item on the balance sheet, divide it by the Total Assets and multiply the result by 100. This gives you the percentage each line item represents of the Total Assets.

Step 4: Interpret the results

Analyze the percentages to identify patterns and trends. Look for items with a significant percentage of Total Assets, as these could represent areas of vulnerability or strength.

Step 5: Compare with industry benchmarks

Compare your results with industry benchmarks or similar companies to see how your business stacks up.

Step 6: Use the results for decision-making

Use the insights gained from the vertical analysis in your decision-making processes. This could influence your budgeting, forecasting, and strategic planning.

Example of Vertical Analysis

Returning to our example above, a vertical analysis of Jackson Widget Company’s balance sheet would look like this.

Horizontal vs. Vertical Analysis

While vertical analysis focuses on the relative size of different line items and their ratios in the same period, horizontal analysis, on the other hand, involves studying the trends and changes in these line items over multiple periods. In vertical analysis, each line item in the financial statement is expressed as a percentage of a base figure in the same period (for example, the total assets or gross sales). However, in horizontal analysis, the relative change in a line item from one period to the next is calculated and typically presented as a percentage change.

This approach provides insights into patterns over time, highlighting increases, decreases, or trends. For example, it can help identify if a company’s accounts receivable has steadily increased over the past three years, which could indicate a problem with credit and collection policies.

Both vertical and horizontal analysis methods provide valuable information/insights. When used together, they offer a comprehensive view of the company’s financial health.

Limitations and Drawbacks of Vertical Analysis

Despite the benefits and insights that vertical analysis can provide, it’s essential to acknowledge its limitations and drawbacks.

Here are a few of those constraints.

• Provides insight into a particular point in time rather than over a period. One major limitation is that vertical analysis only provides a snapshot of a company’s financial health at a specific point in time. This means it may not adequately capture fluctuations that occur throughout the year.
• Financial statement errors can distort results. A useful vertical analysis depends on having accurate financial data. Any errors or manipulations in the figures used can distort the results.
• Lacks context. Vertical analysis also falls short when it comes to providing context. While it’s useful for comparing companies of different sizes, it doesn’t account for differences in industries or markets. A ratio that may seem strong in one sector could be weak in another.
• Doesn’t provide a complete picture. Finally, a vertical analysis of a balance sheet doesn’t provide any information on the company’s cash flows, gross sales or gross profit, all of which are vital aspects of assessing a company’s financial health.

To overcome these limitations, it’s a good idea to use vertical analysis in conjunction with other financial analysis techniques, such as horizontal analysis or ratio analysis, as well as other financial ratios .

Vertical analysis of a balance sheet can be a powerful tool to understand your company’s performance or how two businesses compare. Try it with your next financial analysis and see if it provides useful insights or helps you track progress toward goals. 

If you want to take your variance analysis to the next level, check out FloQast Variance Analysis . It offers a better way to perform flux and budget variance analysis by automating the data collection process and integrating with your ERP. 

Stefan van Duyvendijk

Stefan van Duyvendijk is the Accounting Operations Evangelist at FloQast. Previously, Stefan served as the Corporate Controller for Kodiak Cakes, a private equity owned, leading consumer packaged food company, and as a Controller for Skullcandy, a multinational headphone CPG. These positions followed his five years at KPMG. His experience includes ASC 606 implementation, reduction of financial close timelines, accounting operational improvements, business combinations, financial statement audits, SOX audits and implementation, management reporting, debt, treasury, and systems integrations/implementation.

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Vertical Analysis of Balance Sheets and Financial Statements

• Written by Mary Girsch-Bock
• 15 min read

Vertical analysis is a proportional analysis of financial statements. Also known as common-size analysis, vertical analysis can help analyze company performance, but it is also a useful tool for comparing the financial statements of two companies. 

Vertical analysis can also be used to spot trends over a specific period of time.

Vertical analysis can be used with both income statements and balance sheets, with every line item on the financial statement entered as a corresponding percentage of the base item. 

Vertical analysis is typically used for a single accounting period, whether that’s monthly, quarterly, or annually, and can be particularly helpful when used to compare data for several accounting periods.

What is vertical analysis?

Vertical analysis of financial statements is where each line item on your company’s financial statement is listed as a percentage of the base figure on the statement. 

For example, if vertical analysis is used on an income statement, gross sales (not net sales) would be the base figure and all other line items a percentage of total sales. 

When used with your company’s balance sheet, total assets or total liabilities would be used as the baseline figure, with all subsequent line items shown as a percentage of that total.

Typically used for a single accounting period, vertical analysis is extremely useful for spotting trends. 

Though a useful tool on its own, vertical analysis can be a more useful tool when used in conjunction with horizontal analysis.

The difference between horizontal and vertical analysis

Vertical analysis uses percentages in its analysis, restating either income statement or balance sheet items as a percentage. 

For example, if you’re using vertical analysis with a balance sheet to analyze your assets, your base amount would be your total assets, with each individual item given a percentage in the next column. 

The same would apply when performing a vertical analysis of your liabilities.

Balance sheet vertical analysis uses total assets as a base and assigns a percentage to all line items.

In this example of vertical analysis, you can see that you only need to use balance sheet items from a single accounting period. 

While we’re only showing account balances for assets on this vertical analysis, the same process would be completed for your liability accounts, with your total liabilities and equity serving as your baseline number.

By looking at the balance sheet, you can see that the majority of your company’s assets are current, with only 25% of assets considered fixed, or long-term assets.

When using horizontal analysis, balance sheet totals for two periods are required.

On the other hand, horizontal analysis looks at changes in specific dollar amounts for each period, highlighting the changes line-by-line over two specific accounting periods. 

Horizontal analysis also displays percentage change for each balance sheet item as well.

Vertical analysis is useful for single accounting period analysis, while horizontal analysis is used to compare company performance between two specific accounting periods, whether it’s quarterly or annually. 

In the above example, we’re comparing company performance for 2021 and the previous year, which was 2020.

By looking that the balance sheet above, you can see that while your current asset total went down in accounts receivable, your fixed asset total went up.

While vertical analysis is a great tool for analyzing your current financial position, horizontal analysis is better for spotting trends between two accounting periods.

If your vertical analysis reveals unusual trends or variances, take the time to investigate these changes.

The formula for calculating vertical analysis

The formula for calculating vertical analysis is simple. Using the 2021 balance sheet numbers, we’ll calculate the percentages using the following formula:

Individual Line Item / Total Assets x 100 = Vertical Analysis Percentage

As an example, we’ll calculate the Cash total from the balance sheet above.

$100,000 / $500,000 x 100 = 20%

To complete a vertical analysis for your balance sheet, you’ll need to perform this calculation for each line item that is currently listed on your balance sheet.

Both assets and liabilities/equity have a base number assigned, which is always 100%.

Steps to prepare vertical analysis with your balance sheet

Before you can begin to use vertical analysis, there are a couple of steps you must follow.

• Prepare your balance sheet

Before you can begin a vertical analysis, you must first have a current balance sheet prepared for the accounting period that you wish to analyze. 

If you’re preparing the balance sheet manually, be sure that your asset totals balance with your liability and equity totals.

• Calculate percentages for each line-item account

Once your balance sheet totals are ready, you’re ready to complete your vertical analysis. 

This is done by calculating your line item totals as a percentage of your base number. 

For example, if your base number is $500,000 and your line-item total is $100,000, your percentage is calculated as follows:

Remember, on a balance sheet, your base number is always your total assets and total liabilities, and equity.

• Analyze the results

To complete a vertical analysis, you’ll first need to determine what information you’re looking to obtain. 

For example, many businesses use vertical analysis to compare their financial results to those of other businesses in their industry. 

Because vertical analysis deals with percentages rather than totals, using vertical analysis makes it easy to compare company performance with other companies, even those of different sizes.

Other businesses use vertical analysis over several accounting periods to detect trends or variances. 

Vertical analysis can be particularly helpful if looking to determine cash and accounts receivable balances over several accounting periods.

If your analysis reveals unusual trends or variances, take the time to investigate these changes. 

For example, a significant increase in your accounts receivable balance and a noticeable decrease in cash can signal difficulty in collecting payments from your customers. 

If this continues over several months, revisiting credit practices or collection methods may be in order.

Another potential trouble spot may be an increase in inventory and a decrease in cash, signaling that your inventory movement is sluggish.

Again, keep in mind that these examples only become an issue if they occur consistently over several accounting periods, which is why it’s so important to perform vertical analysis regularly.

Advantages of using vertical analysis for your business

There are several reasons why using vertical analysis can be advantageous for your business.

• Simplicity: Both vertical and horizontal analysis offers some of the easiest ways to analyze company finances.
• Spotting trends: Whether used with a balance sheet or an income statement, vertical analysis is an easy way to compare current results with those from a previous accounting period.
• It can help spot potential issues: Vertical analysis can help you pinpoint trouble areas early, allowing you to take corrective action before the problem gets out of hand.
• Comparison: It can be difficult to measure your company’s performance against another similar company. But using vertical analysis, the emphasis on percentages allows you to make those comparisons seamlessly.
• Useful tool for goal-setting: Vertical analysis allows you to use the results of your latest analysis to set goals. For example, if your cash percentage is 15% and your accounts receivable percentage is 30%, you can choose to set a goal of 35% cash and 10% accounts receivable.

Disadvantages of using vertical analysis for your business

There are advantages and disadvantages to everything, including using vertical analysis. Here are just a few of them.

Results may require additional research: While vertical analysis can provide percentages of your base number, it doesn’t provide you with the information you need to make any changes. Using the accounts receivable example above, vertical analysis can provide you with cash and accounts receivable percentages, but the percentages don’t tell you why your cash percentage is so much lower than your accounts receivable percentage. Only additional research into your credit procedures and collection activities can give you those answers.

• It only provides a small portion of financial data: The information provided by vertical analysis is certainly useful, but it’s only a small portion of the information you will need to run your business profitably. You’ll still need to look at your cash flow statement, liquidity, and net income; none of which can be obtained by vertical analysis.
• It provides better information when used with horizontal analysis: While business owners can certainly use vertical analysis regularly on their own, it becomes more useful when used in combination with horizontal analysis which provides a better look at the changes that occur between accounting periods.

Analysis of the balance sheet can take many forms, with vertical analysis just one of them. 

Vertical analysis can provide business owners and CFOs with valuable information, particularly when used with additional financial ratio analysis. 

While vertical analysis cannot answer why changes have taken place, it’s a useful tool for trend analysis along with pinpointing areas that need further investigation.

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What is Vertical Balance Sheet?

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Vertical balance sheet.

A vertical balance sheet is a presentation of the balance sheet where each line item is listed as a percentage of the total assets. In other words, all assets, liabilities, and shareholders’ equity items are expressed relative to the total assets of the company. This is a form of vertical analysis and is particularly useful for understanding the composition and proportionality of an entity’s financial position.

By converting these amounts to percentages, it’s easier to make both internal comparisons (e.g., how the proportion of long-term debt to total assets has changed over time) and external comparisons (e.g., how the company’s proportion of long-term debt compares to other companies in the same industry).

Example of Vertical Balance Sheet

Let’s consider a hypothetical example to demonstrate a vertical balance sheet. We’ll use a company named “Example Corp” and its balance sheet as of December 31, 2022.

Balance Sheet of Example Corp as of December 31, 2022 (in dollars)

• Cash: $20,000
• Accounts Receivable: $30,000
• Machinery: $100,000
• Buildings: $50,000
• Total Assets: $200,000

Liabilities

• Accounts Payable: $30,000
• Short-term Loans: $10,000
• Long-Term Debt: $60,000
• Total Liabilities: $100,000
• Common Stock: $50,000
• Retained Earnings: $50,000
• Total Equity: $100,000

Vertical Balance Sheet Analysis

To convert this into a vertical balance sheet, we express each line item as a percentage of Total Assets, which in this case is $200,000.

• Cash: $20,000 / $200,000 x 100 = 10%
• Accounts Receivable: $30,000 / $200,000 x 100 = 15%
• Machinery: $100,000 / $200,000 x 100 = 50%
• Buildings: $50,000 / $200,000 x 100 = 25%
• Total Assets: 100%
• Accounts Payable: $30,000 / $200,000 x 100 = 15%
• Short-term Loans: $10,000 / $200,000 x 100 = 5%
• Long-Term Debt: $60,000 / $200,000 x 100 = 30%
• Total Liabilities: 50%
• Common Stock: $50,000 / $200,000 x 100 = 25%
• Retained Earnings: $50,000 / $200,000 x 100 = 25%
• Total Equity: 50%

In this vertical balance sheet, you can see that:

• Current assets make up 25% of the total assets, which may suggest liquidity.
• Fixed assets account for 75% of the total assets, highlighting the company’s long-term investment.
• Liabilities finance 50% of the assets, indicating a 1:1 ratio between liabilities and equity for financing assets.
• Common Stock and Retained Earnings each account for 25% of the total assets, giving insight into how equity is structured.

By using this vertical format, the company can easily compare its financial structure over time or with other companies, regardless of size.

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Financial Statements: The Vertical Method

by Roberto Belingueres | Mar 12, 2021 | Accounting , Articles & Publications

How to Analyze Financial Statements: Vertical Method

As said in previous articles, we have two primary methods to analyze financial statements. Here you will learn how to use both steps by step.

The first method, known as the vertical method, analyzes one fiscal year’s financial information to determine financial statement accounts’ participation in the total of assets, liabilities, and equity in the Balance Sheet or sales in the Profit and Loss statement.

The vertical method uses integral percentages, which means relate each account of the financial statement with a base account valued as 100%.

We assign total assets 100% in the balance sheet and compare it with their accounts’ net values to get each account’s proportion against the full inversion.

Using the same liabilities and equity technique, we compare each account with total liabilities plus equity valued as 100%.

We assign total liabilities and equity 100% to compare with the total liabilities plus equity valued as 100% using the same technique.

On the Profit and Loss statement, total sales, or total income, has a value of 100% and the rest of the accounts use this value as a base percentage for comparison.

To ensure proper analysis, we recommend going through the following steps:

Having the financial statements in an Excel format will be easier to make the necessary calculations. Make sure you include the complete accounts next to their amounts and the year correspondence. In the following example, we can see how it must look.

Include a column next to the amounts inserted to be used to present the percentages. The vertical method divides each account’s value between the total assets, liabilities plus equity, or income.

In this example, you can see those basic accounts:

Once you obtained the percentages, you will see on the financial statement how much each account represents and which one is the most or less “important” in terms of inversion.

In this example, accounts receivable have all our attention because it represents more than 50% of the company assets. We chose it because it accounts for more weight, value, or effect in the total assets.

Focusing on one account, we have to investigate by looking into its composition. For example, are those accounts receivable form with debts of the company’s associates or clients? Is the total amount composing of national or foreign currency?

You could get that information by having an interview with the accounting department, the administrator, or even directly by the company’s owner; if audited financial statements are available, you could read it from its notes.

In our example, we can see that accounts receivable are composed of commercials or clients’ accounts, payments in advance to suppliers, and prepaid payments to related parties or companies.

Finally, we must determine the effect of the account. In this case, our conclusion will be as follow: In 2019, the total assets had a value of 62,131,689, representing 100% of the account, which has 74.11% of current assets and 25.89% of non-current assets. In those percentages, the most valued account is the accounts receivable with 51.74%.

These steps can help us understand that most assets are not liquid. As users of the financial statements, we could investigate when those people will pay the company or compensate with accounts payable and the clients, related companies with debts, etc.

Written by: Andrea Diaz

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Vertical Balance Sheet

What is a vertical balance sheet.

A vertical balance sheet is a presentation structure with a single column of figures, starting with asset line items and ending with shareholders’ equity line items. 

In a vertical balance sheet, you must provide the line items in decreasing order of liquidity within each of these categories. As a result, the presentation inside the topmost block of line items (for assets) frequently starts with cash. It finishes with fixed assets (far less liquid than cash) or goodwill. For the same reason, the liabilities section typically begins with accounts payable and ends with long-term debt.

Why is a Vertical Balance Sheet Crucial?

A vertical balance sheet allows the reader to compare the statistics on the balance sheet for a single time. For example, you can compare your current assets and current liabilities total to evaluate a company’s liquidity as of the balance sheet date.

Vertical Balance Sheet Format

Vertical Vs Horizontal Balance Sheet

The horizontal balance sheet format is an alternative to the vertical balance sheet format, in which assets appear in column one and liabilities and shareholders’ equity appear in column two. Therefore, the totals in each column should always be the same in this format.

The popularity of vertical balance sheets is more as it allows you to add balance sheets for numerous periods on a single page. The incorporation is by utilising a side-by-side presentation arrangement covering many reporting periods.

How to Prepare a Vertical Balance Sheet

You must already be familiar with balance sheet generation . Now to dive deeper into vertical balance sheet making, keep note of the steps below:

Disclosure Changes

Any change in treatment or disclosure required by the Act, consisting of any addition, alteration, substitute, or deletion to the headings or subheadings of the financial statements or statements forming part of them, can be made. The provisions of this Schedule will be changed accordingly.

Disclosure Additions

The disclosure obligations indicated in a vertical balance sheet are in addition to, not in place of, the disclosure standards outlined in the Accounting Standards imposed by the Companies Act of 2013. You can make additional disclosures specified per accounting standards in the notes to accounts. These disclosures, however, are not required to be included on the face of the Financial Statements.

Notes to Accounts Data

Apart from the data shown in the Financial Statements, Notes to Accounts must consist of information such as narrative explanations. Or else, the notes should contain disaggregation of items recognised in those statements and information concerning items that do not qualify for recognition.

Financial Statement Inclusions

Each item on a vertical balance sheet and Profit and Loss Statement must cross-reference any pertinent information in the notes to accounts. 

When you create Financial Statements, include the notes to accounts. However, do not offer excessive detail that may not benefit financial statement consumers and fail to give vital information owing to excessive aggregation.

Financial Statement Figures

Depending on the company’s turnover, you can round off the figures in the Financial Statements. For example, if the total revenue is almost 100 crore rupees, round it to the next hundreds, thousands, lakhs, millions, or decimals. If the turnover exceeds 100 crore rupees, rounding to the nearest lakhs, millions, crores, or decimals is permitted.

First Financial Statements

Following incorporation, the first financial statements presented to the company must include corresponding amounts (comparatives) for all the items shown in the financial statements, including notes, for the immediately preceding reporting period.

Rather than struggling to make a vertical balance sheet, you can opt for GST billing and accounting software like myBillBook to meet your vertical balance sheet requirements. It offers a balance sheet report in which you can enter assets and liabilities and finally download the report.

FAQs about vertical balance sheet

What is a vertical balance sheet.

A vertical balance sheet is one with a column of statistics beginning with asset line items and ending with shareholders' equity line items.

Why do you need a vertical balance sheet?

You will need a vertical balance sheet to allow the reader to compare the statistics on the balance sheet for a single time.

Does a vertical balance sheet serve the same purpose as a horizontal balance sheet?

Yes, but the formats are different. The horizontal balance sheet format has assets shown in column one, and liabilities and shareholders' equity appears in column two. The totals in each column should always be the same in this format.

What do notes to accounts in a balance sheet contain?

Notes to accounts must include information, like narrative descriptions of items recognised in those statements and information about items not qualified for recognition in those statements.

What Do You Mean by a Balance Sheet?

The balance sheet displays a company's total assets and how the company finances the assets through debt or equity. In addition, it denotes the net worth statement or a statement of financial condition.

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• Vertical Balance Sheet

VERTICAL BALANCE SHEET

A vertical balance sheet is one in which the accounting report format or design is shown in a sole column of numbers, starting with resource or asset details, trailed by liability details, and finishing with investors’ value or shareholders’ equity details. Inside every one of these classes, details are introduced in the diminishing order of liquidity. In this manner, the presentation inside the highest category of details (for resources or assets) starts with cash and, for the most part, finishes with fixed resources (which are significantly less liquid than money) or altruism. Also, the liabilities category starts with creditor liabilities or accounts payable and ordinarily finishes with long-term obligation or debt, for a similar explanation.

The goal of a vertical balance sheet is for the peruser to make examinations and comparisons between the numbers on the monetary record for a solitary period. For instance, somebody may compare the total current resources or assets with the total current liabilities to appraise the liquidity of a business as of the accounting report or balance sheet date.

Format of a Vertical Balance Sheet:

Name of the company

Balance sheet as on XXXXXXXX

(Amount in rupees)

Note: The ( * ) star marked items will not be evaluated in the accounting treatment as per the CBSE circular.

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The vertical balance sheet

Home » Bookkeeping » The vertical balance sheet

Seeing the horizontal analysis of every item allows you to more easily see the trends. It will be easy to detect that over the years the cost of goods sold has been increasing at a faster pace than the company’s net sales.

The amounts from five years earlier are presented as 100% or simply 100. The amounts from the most recent years will be divided by the base year amounts. For instance, if a most recent year amount was three times as large as the base year, the most recent year will be presented as 300. If the previous year’s amount was twice the amount of the base year, it will be presented as 200.

It can also be used to project the amounts of various line items into the future. To conduct a vertical analysis of balance sheet, the total of assets and the total of liabilities and stockholders’ equity are generally used as base figures. All individual assets (or groups of assets if condensed form balance sheet is used) are shown as a percentage of total assets.

Horizontal analysis is the comparison of historical financial information over a series of reporting periods, or of the ratios derived from this information. It is used to see if any numbers are unusually high or low in comparison to the information for bracketing periods, which may then trigger a detailed investigation of the reason for the difference.

The income statement also uses this presentation with revenue entries referencing total revenues and expense entries referencing total expenses. Vertical analysis makes it much easier to compare the financial statements of one company with another, and across industries. This is because one can see the relative proportions of account balances. ABC Company’s income statement and vertical analysis demonstrate the value of using common-sized financial statements to better understand the composition of a financial statement. It also shows how a vertical analysis can be very effective in understanding key trends over time.

From the balance sheet’s horizontal analysis you may see that inventory and accounts payable have been growing as a percentage of total assets. Horizontal analysis of financial statements can be performed on any of the item in the income statement, balance sheet and statement of cash flows. For example, this analysis can be performed on revenues, cost of sales, expenses, assets, cash, equity and liabilities. It can also be performed on ratios such as earnings per share (EPS), price earning ratio, dividend payout, and other similar ratio.

The current liabilities, long term debts and equities are shown as a percentage of the total liabilities and stockholders’ equity. To calculate the quick ratio, locate each of the formula components on a company’s balance sheet in the current assets and current liabilities sections.

The ratio tells creditors how much of the company’s short term debt can be met by selling all the company’s liquid assets at very short notice. Cash ratio(also calledcash asset ratio)isthe ratio of a company’s cash and cash equivalent assets to its total liabilities. Cash ratio is a refinement of quick ratio and indicates the extent to which readily available funds can pay off current liabilities.

Plug the corresponding balance into the equation and perform the calculation. The quick ratio measures the dollar amount of liquid assets available against the dollar amount of current liabilities of a company. The balance sheet uses this presentation on individual items like cash or a group of items like current assets. Cash is listed as an individual entry in the assets section with the total balance being listed on the left and its percentage of total assets being listed on the right.

Indeed, sometimes companies change the way they break down their business segments to make the horizontal analysis of growth and profitability trends more difficult to detect. Accurate analysis can be affected by one-off events and accounting charges. Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios, or line items, over a number of accounting periods. Horizontal analysis of financial statements involves comparison of a financial ratio, a benchmark, or a line item over a number of accounting periods. Horizontal analysis allows the assessment of relative changes in different items over time.

Using horizontal analysis

Generally accepted accounting principles (GAAP) are based on consistency and comparability of financial statements. Consistency is the ability to accurately review one company’s financial statements over a period of time because accounting methods and applications remain constant.

The quick ratio is an indicator of a company’s short-term liquidity position and measures a company’s ability to meet its short-term obligations with its most liquid assets. Since it indicates the company’s ability to instantly use its near-cash assets (assets that can be converted quickly to cash) to pay down its current liabilities, it is also called the acid test ratio. An acid test is a quick test designed to produce instant results—hence, the name.

What is an example of horizontal analysis?

Horizontal analysis (also known as trend analysis) is a financial statement analysis technique that shows changes in the amounts of corresponding financial statement items over a period of time. It is a useful tool to evaluate the trend situations. The statements for two or more periods are used in horizontal analysis.

First, we should review the income statements as they’re presented in dollar terms. The company’s sales have grown over this time period, but net income is down sharply in year three.

• Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis.
• To illustrate horizontal analysis, let’s assume that a base year is five years earlier.

By doing this, we’ll build a new income statement that shows each account as a percentage of the sales for that year. As an example, in year one we’ll divide the company’s “Salaries” expense, $95,000 by its sales for that year, $400,000. That result, 24%, will appear on the vertical analysis table beside Salaries for year one.

Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis. Vertical analysis is a method of financial statement analysis in which each line item is listed as a percentage of a base figure within the statement. To illustrate horizontal analysis, let’s assume that a base year is five years earlier. All of the amounts on the balance sheets and the income statements will be expressed as a percentage of the base year amounts.

Horizontal or trend analysis of financial statements

Despite having a healthy healthy accounts receivable balance, the quick ratio might actually be too low, and the business could be at risk of of running out of cash. Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. This means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets. On the other hand, a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities.

Example of Horizontal Analysis

Quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. Quick ratio is viewed as a sign of a company’s financial strength or weakness; it gives information about a company’s short term liquidity.

Potential creditors use this ratio as a measure of a company’s liquidity and how easily it can service debt and cover short-term liabilities. The most basic definition of acid-test ratio is that, “it measures current (short term) liquidity and position of the company”. To do the analysis accountants weight current assets of the company against the current liabilities which result in the ratio that highlights the liquidity of the company.

It also indicates the behavior of revenues, expenses, and other line items of financial statements over the course of time. Horizontal analysis allows investors and analysts to see what has been driving a company’s financial performance over a number of years, as well as to spot trends and growth patterns such as seasonality. It enables analysts to assess relative changes in different line items over time, and project them into the future. A business may have a large amount of money as accounts receivable, which may bump up the quick ratio. This may include essential business expenses and accounts payable that need immediate payment.

Horizontal analysis of the income statement is usually in a two-year format, such as the one shown below, with a variance also shown that states the difference between the two years for each line item. An alternative format is to simply add as many years as will fit on the page, without showing a variance, so that you can see general changes by account over multiple years. A third format is to include a vertical analysis of each year in the report, so that each year shows expenses as a percentage of the total revenue in that year.

Comparability is the ability to review side-by-side two or more different companies’ financials. Horizontal analysis not only improves the review of a company’s consistency over time directly, but it also improves comparability of growth in a company to that of its competitors as well.

Implementing vertical analysis

Vertical analysis restates each amount in the income statement as a percentage of sales. This analysis gives the company a heads up if cost of goods sold or any other expense appears to be too high when compared to sales. Reviewing these comparisons allows management and accounting staff at the company to isolate the reasons and take action to fix the problem(s). Understanding horizontal and vertical analysis is essential for managerial accounting, because these types of analyses are useful to internal users of the financial statements (such as company management), as well as to external users. If analysis reveals any unexpected differences in income statement accounts, management and accounting staff at the company should isolate the reasons and take action to fix the problem(s).

Comparative retained earnings statement with horizontal analysis:

The most common use of vertical analysis is within a financial statement for a single reporting period, so that one can see the relative proportions of account balances. Vertical analysis is also useful for trend analysis, to see relative changes in accounts over time, such as on a comparative basis over a five-year period. For example, if the cost of goods sold has a history of being 40% of sales in each of the past four years, then a new percentage of 48% would be a cause for alarm. Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios or line items, over a number of accounting periods. The quick ratio is ameasure of a company’s ability to meet its short-term obligations using its most liquid assets (near cash or quick assets).

How to Create Vertical Balance Sheet Format in Excel (In 4 Steps)

Excel is a wonderful tool for creating balance sheets as it provides many valuable features that are very easy to apply. In this article, we will learn how to create a vertical balance sheet format in Excel.

Introduction to Vertical Balance Sheet

A vertical balance sheet is one in which the line items on the balance sheet are shown as a single column of figures, starting with assets, then liabilities, and finally shareholders’ equity. Line items are displayed inside each of these categories in decreasing order of liquidity. As a result, the presentation within the top block of line items (for assets) starts with cash and typically concludes with fixed assets or goodwill (which are far less liquid than cash). Similar to the assets part, the liabilities section often starts with accounts payable and finishes with long-term debt.

How to Create Vertical Balance Sheet Format in Excel: 4 Easy Steps

In this section, we will see how we can create a vertical balance sheet format in Excel. For ease of illustration, we have divided the whole process into 4 steps. Let’s begin.

Step 01: Make Heading of the Balance Sheet

The first step is to create a heading for the balance sheet. A beautiful and well-formatted heading increases the aesthetic value of the balance sheet. Follow the steps below to prepare this.

• First, open a blank Excel sheet. On the top of the sheet, take some merged cells and write “ Vertical Balance Sheet ” with a large font size and suitable background color. Also, make the font bold.

• In the figure above, we merged and centered the B2:F2 and wrote the heading.
• Now in the cell below, write the date with suitable formatting.

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Step 02: Input Assets Data

After writing the heading and date, we will move to the main part of our balance sheet. As we know, a balance sheet consists of three major components, i.e., Assets, Liabilities, and Stakeholder’s Equity. The first component that appears on the balance sheet is Assets. To input the asset data, follow the steps below.

• First, write down the heading “ Assets ” in some merged cells with suitable font size and background color.

• Now, we will first input the data of the current assets. Hence, write the heading “ Current Assets ” in the same number of merged cells, but unlike the previous cells, it will be left aligned.

• Below the heading, merge one less number of cells (B6 to E6) and make it left aligned.

• Now give input your current assets and their corresponding values on the adjacent right cells.

• It is better to express figures in the accounting format. So we will convert the number formatting of the whole F column into Accounting. To do that, click on the column heading F, then go to the Number group and click on the $

• As a result, all the numbers will convert into the accounting format.

• Now, we will calculate the total current asset by the following formula.

• Similarly, we will input the data of Fixed Assets.

• Now, calculate the total fixed assets with the following formula

• Now to calculate total assets, we add Total Current Assets ( F9 ) and Total Fixed Assets( F13 ).

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Step 03: Input Liabilities Data

After inputting assets data, we have to insert the liabilities data. There are two types of liabilities: Current and Long Term. Follow the steps below to insert liabilities data.

• Like in the Assets, input a heading of Liabilities in some merged cells with proper formatting.

• Now insert current liabilities data like the figure below and calculate total liabilities with the formula below.

• Now input the Long Term Liabilities and calculate the total long-term liabilities by the formula below.

• Now adding the Total Curren Liabilities and Total Long Term Liabilities, we get the total liabilities.

Read More:  Balance Sheet Format in Excel with Formulas

Step 04: Input Stakeholder’s Equity

This is the last item we need to input. Follow the steps below to input the Stakeholder’s Equity data.

• Like the 2nd and 3rd steps, write a heading for Stakeholder’s Equity.

• Now input all the items of Stakeholder’s Equity and their corresponding values.

• Now calculate the Total Equity by the following formula.

• And lastly, we have to calculate the Total Liabilities and Equity by adding Total Liabilities( F24 ) and Total Equity ( F28 )

So, overall our balance sheet will look like this.

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Things to Remember

• In a balance sheet, the amount of Total Assets must be equal to Total Liabilities and Equity .
• You have to add additional elements according to your needs that are not given in the sheet. Then you need to adjust the formula as well.

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Breaking Down The Balance Sheet

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A company's financial statements — balance sheet , income , and cash flow statements —are a key source of data for analyzing the investment value of its stock. Stock investors, both the do-it-yourselfers and those who follow the guidance of an investment professional, don't need to be analytical experts to perform a financial statement analysis . Today, there are numerous sources of independent stock research, online and in print, which can do the "number crunching" for you. However, if you're going to become a serious stock investor, a basic understanding of the fundamentals of financial statement usage is a must. In this article, we help you to become more familiar with the overall structure of the balance sheet.

The Structure of a Balance Sheet 

A company's balance sheet is comprised of assets , liabilities , and equity . Assets represent things of value that a company owns and has in its possession, or something that will be received and can be measured objectively. Liabilities are what a company owes to others— creditors , suppliers, tax authorities, employees, etc. They are obligations that must be paid under certain conditions and time frames. A company's equity represents retained earnings and funds contributed by its shareholders , who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment .

The relationship of these items is expressed in the fundamental balance sheet equation:

Assets = Liabilities + Equity

The meaning of this equation is important. Generally, sales growth, whether rapid or slow, dictates a larger asset base —higher levels of inventory, receivables , and fixed assets ( plant, property, and equipment ). As a company's assets grow, its liabilities and/or equity also tend to grow in order for its financial position to stay in balance.

How assets are supported, or financed, by a corresponding growth in payables , debt liabilities and equity reveals a lot about a company's financial health . For now, suffice it to say that depending on a company's line of business and industry characteristics, possessing a reasonable mix of liabilities and equity is a sign of a financially healthy company. While it may be an overly simplistic view of the fundamental accounting equation , investors should view a much bigger equity value compared to liabilities as a measure of positive investment quality, because possessing high levels of debt can increase the likelihood that a business will face financial troubles.

Balance Sheet Formats

Standard accounting conventions present the balance sheet in one of two formats: the account form (horizontal presentation) and the report form (vertical presentation). Most companies favor the vertical report form, which doesn't conform to the typical explanation in investment literature of the balance sheet as having "two sides" that balance out.

Whether the format is up-down or side-by-side, all balance sheets conform to a presentation that positions the various account entries into five sections:

• Current assets (short-term): items that are convertible into cash within one year • Non-current assets (long-term): items of a more permanent nature As total assets these = • Current liabilities (short-term): obligations due within one year • Non-current liabilities (long-term): obligations due beyond one year These total liabilities + • Shareholders\' equity (permanent): shareholders\' investment and retained earnings

Account Presentation

In the asset sections mentioned above, the accounts are listed in the descending order of their liquidity (how quickly and easily they can be converted to cash). Similarly, liabilities are listed in the order of their priority for payment. In financial reporting, the terms "current" and "non-current" are synonymous with the terms "short-term" and "long-term," respectively, and are used interchangeably .

It should not be surprising that the diversity of activities included among publicly-traded companies is reflected in balance sheet account presentations. The balance sheets of utilities, banks, insurance companies, brokerage and investment banking firms, and other specialized businesses are significantly different in account presentation from those generally discussed in investment literature. In these instances, the investor will have to make allowances and/or defer to the experts.

Lastly, there is little standardization of account nomenclature. For example, even the balance sheet has such alternative names as a "statement of financial position" and "statement of condition." Balance sheet accounts suffer from this same phenomenon. Fortunately, investors have easy access to extensive dictionaries of financial terminology to clarify an unfamiliar account entry.

The Importance of Dates

A balance sheet represents a company's financial position for one day at its fiscal year end, for example, the last day of its accounting period , which can differ from our more familiar calendar year . Companies typically select an ending period that corresponds to a time when their business activities have reached the lowest point in their annual cycle, which is referred to as their natural business year.

In contrast, the income and cash flow statements reflect a company's operations for its whole fiscal year—365 days. Given this difference in "time," when using data from the balance sheet (akin to a photographic snapshot) and the income/cash flow statements (akin to a movie) it is more accurate, and is the practice of analysts , to use an average number for the balance sheet amount. This practice is referred to as "averaging," and involves taking the year-end (2019 and 2020) figures—let's say for total assets—and adding them together, and dividing the total by two. This exercise gives us a rough but useful approximation of a balance sheet amount for the whole year 2020, which is what the income statement number, let's say net income , represents. In our example, the number for total assets at year-end 2020 would overstate the amount and distort the return on assets ratio (net income/total assets).

The Bottom Line

Since a company's financial statements are the basis of analyzing the investment value of a stock, this discussion we have completed should provide investors with the "big picture" for developing an understanding of balance sheet basics.

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What is a balance sheet? A key financial document used to evaluate a company's financial health

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• A balance sheet is a type of financial statement that lists a company's assets, liabilities, and shareholders' equity.
• The assets should be in 'balance' and equal the total liabilities and shareholders' equity.
• Balance sheets can provide important financial insight but are also limited to a single day in time.

A balance sheet is a type of financial statement that outlines a particular business's assets as well as liabilities, plus the shareholders equity on a specific day. It's used to evaluate a company's financial health and is also known as a 'statement of financial position.' Businesses use various accounting tools — including a balance sheet — to assess where a company is at financially at a specific point in time.  

How a balance sheet works  

When it comes to evaluating a company's financial wellbeing, there are different types of financial statements to look at. A balance sheet is just one type of statement and differs a bit from a profit and loss statement (P&L), which is another commonly used financial report used in evaluating a business' finances. 

"I like to explain to clients that the profit and loss statement is a movie, while the balance sheet is a photo. The P&L reflects income and expenses over time, but the balance sheet shows the company's financial position within a single fixed moment," explains Courtney Barbee, owner and COO at The Bookkeeper .

So for example, a P&L statement may be for Q4, a balance sheet may be for one single day at the end of a particular accounting period. 

The balance sheet equation is: Assets = Liabilities + Equity

Let's review what these parts mean individually: 

• Assets. This refers to items of monetary value. This includes current and non-current assets and is listed in order of liquidity. So for example, you'll have your current assets which include cash and cash equivalents, accounts receivable, and inventory. Non-current assets can include things like equipment, investments, copyrights and intellectual property 
• Liabilities. This includes money owed for debt or expenses. This also includes current and non-current liabilities. Current liabilities can be accounts payable, current debt obligations, and part of long-term debt obligations. Non-current liabilities may include bonds issued by the company and long-term debt obligations may also be classified under non-current liabilities as well. 
• Equity. This is   the equity refers to the shareholders' equity and includes how much shareholders have invested in the company as well as the retained earnings. The shareholders' equity can also refer to the net assets, which is the total liabilities subtracted from the total of assets. 

"It's called the balance sheet because it reflects the accounting equation, Assets = Liabilities + Shareholder's Equity, in balance," explains Barbee. "The top portion is the assets: items of value, tangible or intangible , that the company owns. These might include cash, Accounts Receivable, equipment, or even things like a trademark or prepaid expenses." 

Reading a balance sheet 

Given the name "balance sheet," the assets and liabilities plus equity must be "balanced." In other words, the value of your assets must be the same value as the total of your liabilities and equity combined. 

"On the balance sheet, assets are listed in order of how readily convertible they are into cash. Liabilities are listed in order of how soon the requisite payment is due and payable," explains Phil Weiss, CFA, CPA and principal at Apprise Wealth Management .

When it comes to balance sheet presentation, you can find either a vertical balance sheet such as the one pictured below where items are listed in a column that is read vertically, or up and down. 

There's also the possibility of a horizontal presentation, where assets and liabilities and equity are side-by-side, read horizontally. In this case, on the right side you'll see liabilities listed as well as the shareholders' equity and on the left side, there are the assets listed. Vertical presentation tends to be more common. 

"Beneath the assets are the Liabilities, the things the companies owes. This isn't just debt such as loans or credit cards, but could also include unearned revenue," notes ​​Barbee. "Paired with the liabilities is the Shareholders' Equity. All of the P&L statement, up until the date of the Balance Sheet, is actually housed in this portion as Retained Earnings."

The balance sheet equity line may include more than meets the eye and can be an important metric for investors to review. 

"It also includes equity that has come in via things like cash infusions or stock sales, as well as equity which has left via distributions. The Liabilities and Shareholders' Equity sum together to equal the Assets, resulting in the Balance Sheet," explains Barbee.

Example of a balance sheet

As an investor, you can review important financial statements from publicly traded companies through the Securities and Exchange Commission (SEC) . Here's an example of a balance sheet from Apple Inc. 

As you can see, there are assets divided by current assets, including their subcategories, as well as non-current assets and their respective sub-categories. Below that, you can see current liabilities and non-current liabilities with their respective subcategories. At the bottom, you can review the shareholders' equity. 

From the image below, you can see the total assets amount matches the total liabilities and shareholders' equity amount. 

Pros and cons of using a balance sheet  

A balance sheet is one of the key financial statements that businesses should use as part of evaluating their company finances. It's also possible for investors to review balance sheets of publicly-traded companies to determine their profitability. It's important to understand the benefits of reviewing a balance sheet and understanding its limitations as well. 

How investors can use a balance sheet 

Investors can look at a company's assets and liabilities and look at liquidity and returns before deciding to invest in a particular company. "Investors look at balance sheets to help assess a company's financial viability," says Weiss.

Another important line to review is the shareholders' equity line where you can see important information about shares and equity. 

Market value vs. book value

When assessing whether an asset is appropriately valued, market value is typically analyzed side-by-side with book value. Book value is basically the value of a company according to its balance sheet.

To get a company's book value, you take the difference between a company's total assets and total liabilities. 

Book value takes a little more work to calculate than market value. A stock is generally considered undervalued if its market value is well below its book value, since this means the stock is being traded at a discount. However, the opposite is not necessarily true.

Profitable companies often have higher market values than book values. This is because investors are optimistic about their potential for growth and expansion, and also because some companies have more earnings power, or ability to generate profit, than current assets. In some cases, however, a higher market than book value could, in fact, indicate that the asset is overvalued.

Balance sheet FAQs

The price-to-book ratio expresses a company's stock share price in relation to its book value per share (BVPS). "Book value" refers to a company's intrinsic, financial worth — specifically, the difference between all its assets and all its expenses and debts.

The bottom line on balance sheets

A balance sheet is just one of many financial statements that companies and investors alike can use to evaluate the financial picture of a company. It can offer important insights at a specific moment of time, but may not be as useful for looking at growth. In tandem with other financial statements, you can get even greater insights. 

"In general, if you're trying to understand a company's financial health, you want to review its income statement, cash flow statement, and balance sheet," suggests Weiss. "The combination of all three can give a better picture of a company's financial health than any individual financial statement." 

That way you have all the information you need to make an informed decision, with all the data available for you to review.

• Main content

Simple Balance Sheet Structure Breakdown (by Each Component)

• Equity Accounting , Financial Statements
• May 17, 2022

Updated 6/3/2024

“ Never invest in a company without understanding its finances. The biggest losses in stocks come from companies with poor balance sheets .” Peter Lynch

The ability to read a company’s financials, such as the income statement, balance sheets, and cash flow statement, is a key data source for investors, both do-it-yourselfers and institutional investors.

As an investor, you don’t need to be an expert at deciphering financial statements and modeling, but at least being fluent in the accounting language will go a long way toward your success as an investor.

In our continuing series on understanding accounting and financial statements, we will unlock the secrets within the balance sheets.

The next focus is on the balance sheet and its components. Every company, as a public entity, must file a balance sheet, and its structure helps inform investors about a company’s financial strength.

Aside from financials such as banks and insurance companies, reading companies’ balance sheets is fairly straightforward.

Analysis of the balance can uncover clues to a company’s liquidity and ability to survive challenges such as those faced by businesses today.

In today’s post, we will learn:

Breaking Down the Balance Sheet Structure

Asset side of the equation.

• Liability Side of the Equation
• Equity Side of the Equation

Let’s dive in and uncover more about the balance sheet structure.

The balance sheet remains one of the big three financial statements that all public companies must file. The others are the income statement and statements of cash flows.

The objective of the balance sheet (or statement of financial position) remains to provide information concerning a company’s assets and equity interests at a specific time .

Assets represent items of value the company owns and has in its possession. Or others that will be received and can be measured objectively.

Companies owe creditors, such as employees, suppliers, tax authorities, and liabilities. The liabilities are obligations with schedules, conditions, and time frames that govern when, how much, and how often the company pays the liabilities back.

Equity or shareholders’ equity consists of retained earnings and monies shareholders contribute in exchange for ownership.

We can best express the balance sheet as a formula. The formula equals:

Assets = Liabilities + Equity

The balance sheet formula remains important, and we should consider it this way: As sales grow, the asset base will grow as well. This dictates higher inventories, receivables, and fixed assets, like plant, property, and equipment. As the company’s assets grow, liabilities and equity grow in lockstep, and the financial positions must stay balanced.

How the assets are supported by financing or the corresponding growth in payables, debt, and equity tells us much about the company’s financial health.

When considering a company’s financial health, a good mix of liabilities and equity supporting the assets is a sign of a financially healthy company.

A simple view of the balance sheet equation is having assets equal to a smaller portion of liabilities supporting those assets while having a larger portion of equity than liabilities supporting those assets—keeping in mind that equity-creating revenues are cheaper than debt-creating revenues.

We want to consider the balance sheet equation because debt financing at higher levels lends more risk to your investment; as a company struggles, the possibility of defaulting on the debt rises, and the risk of bankruptcy also increases.

The balance sheet is a snapshot of any public company’s financial condition over time. Every quarterly or annual report will contain a balance sheet, and we need to think of those results as frozen in time and depending on the day.

Standard accounting practices allow for presenting the balance sheet in two formats:

• Horizontal presentation
• Vertical presentation

Most companies use vertical presentations; I have never seen a horizontal presentation in a public company. The vertical presentation doesn’t allow for the “balancing” of the sheet, as you don’t see the two sides balancing out like you would in accounting class.

Regardless of whether it is a horizontal or vertical presentation, all balance sheets conform to the presentation that presents the positions of account entries into five sections :

• Current assets
• Non-current assets
• Current liabilities
• Non-current liabilities
• Shareholders’ equity

Such that Assets equals:

Current Assets

Liabilities: current liabilities + non-current liabilities + shareholders’ equity

As mentioned above, the balance sheets for utilities, banks, insurance companies, brokerages, and investment banks remain significantly different. They require further analysis and understanding of the terminology used for those businesses.

Another note about balance sheets: there remains little normalization of the nomenclature or naming of said sheets. For example, one company may refer to its balance sheet as a “statement of financial condition” or “financial condition.” Unfortunately, this disorder also applies to the accounts of balance sheets, so there is no uniformity in labeling accounts for the balance sheet.

Okay, let’s uncover each balance sheet section and define its different components.

As we work through our balance sheet, we will use Microsoft’s (MSFT) as our example and their latest 10-k, dated June 30, 2022

For our analysis, assets drive a company’s economic resources. The company must have acquired the rights to said assets, and they are likely to continue contributing to Microsoft’s future net cash flows.

Items such as cash are unquestionably assets because they have purchasing power that represents a future economic benefit to Microsoft.

Let’s start to look at each component of the asset side of the equation of the balance sheet structure.

A note about the order in which we find the assets listed in the asset section: the accounts are listed in the order of liquidity or how quickly those assets can convert to cash. So, accounts receivable are more liquid than inventories, for example. The above point is important to remember when analyzing the company’s ability to meet its obligations.

The asset section of the balance sheet has two components, which we will break down by line items.

Current assets are the most liquid assets owned by the business and are the accounts or line items listed in order of liquidity.

Current assets can be considered assets that a company can liquidate within one calendar year. Consider inventory, for example, as something used up within one calendar year.

Current assets are important because they represent the funds a business can use to fund day-to-day operations for the next calendar year. We can also think of it as the liquid assets of the business.

Let’s next look at the accounts associated with current assets.

Cash and Cash Equivalents

These are the most liquid assets, appearing on the first line of the assets section. Cash equivalents are also in this line item. Cash equivalents contain securities that are extremely short-term, such as three months.

These securities are short-term bonds, money market accounts, or treasuries. The company wants to generate some income by using this account to generate a small amount of income from monies not used for the immediate future.

We can find More information regarding the cash equivalents in the notes section of the financials, typically listed as the marketable or investment section.

Microsoft lists $13,576 million in cash and cash equivalents. The company also lists the short-term investments separately, for which we can see a total of $122,951 million. Keep in mind that these securities are very short-term in nature, and the ability for quick liquidity is paramount.

Accounts Receivable

The accounts receivable accounts for all amounts owed to the company by customers that the company has not yet collected. The bad debt accounts or customers are unlikely to pay to subtract from this account.

This account decreases as Microsoft collects from its customers, and cash will increase by the same amount as collected.

Microsoft lists accounts receivable as $44,261 million.

The inventory line item contains raw materials, work-in-progress goods, and finished goods. Think of inventories as goods waiting to be sold by the company, whether cars, computers, or phones.

In many companies, inventory might be the largest line item in the current asset section.

The costs associated with the production or acquisition of inventory are listed in the costs of goods sold line item of the income statement.

Microsoft lists inventories of $3,742 million under the current assets section.

Other current assets

Other current assets are typically smaller items listed under this catch-all section.

Items include advances paid to an employee, a piece of property listed for sale, or restricted cash or investments.

Microsoft is listing its balance sheet of $16,924 million of other current assets.

Non-Current Assets

These assets are items that the company uses for a longer life, such as property, plant, and equipment or intangible assets.

The non-current assets have a longer life, typically longer than at least a year, and include goodwill, among others.

Plant, Property, and Equipment (PP&E)

The PP&E line item represents the company’s fixed assets. It doesn’t include depreciation, and some companies list their PP&E on separate lines, such as plants.

The PP&E account will vary from company to company, and for many companies, this will easily be the biggest line item under non-current assets.

Microsoft lists the plant, property, and equipment of $74,398 million on the balance sheet.

Goodwill is probably one of the more controversial items on the balance sheet as it contains information that is not always the most transparent. It takes some sleuthing to determine what makes up the goodwill.

Typically, goodwill expresses the intangible amounts from an excess purchase of another company. Items contained in goodwill can be proprietary intellectual property or branding.

We can calculate goodwill by subtracting the market value of the assets and liabilities from the purchase price of the assets. Businesses must review the value of goodwill annually and record any impairments to the asset’s fair value.

The goodwill for Microsoft is $67,524 million for 2022.

Intangible Assets

The intangible asset line items include the company’s intangible fixed assets. Some of these items, such as patents, licenses, or a secret sauce or formula, may or may not be identifiable.

Microsoft lists intangible assets of $11,298 million on its balance sheet.

That concludes the asset section of Microsoft’s balance sheet; remember, the other side of the equation must balance the assets.

Let’s move on to the liability section of the balance sheet.

Liabilities Side of the Equation

Liabilities are the monies that the company owes to help support its assets. Think of them as accounts that support the purchase of inventory to sell the items the company sells.

Or they are financing those purchases for inventories, for example.

Remember that the accounting equation for the balance sheet means that the liabilities and shareholders’ equity must equal the assets for the financial statement to balance.

Let’s walk through some of the line items most commonly seen in the liability section of the balance sheet.

Current Liabilities

Current liabilities are short-term obligations due within the calendar year or operating cycle. They settle by using current assets, thus determining companies’ liquidity using ratios such as the current or quick ratio.

Examples of current liabilities include items such as:

• Accounts payable
• Short-term debt
• Notes payable
• Income taxes owed

Ok, let’s look at some of the more common current liabilities.

Accounts Payable

Accounts payable is the amount the company owes its suppliers for the goods or services it has purchased on credit from them. Accounts payable are expected to settle within the year of purchase and are considered the most liquid of all current liabilities.

Microsoft has an account payable of $19,000 million listed on its balance sheet.

Current Portion of Long-term Debt

The above line item refers to the short-term portion of long-term debt the company is due within the calendar or operating year. For example, if a company takes out a 10-year bank loan, the current portion of that loan is listed under this account.

For many companies, the short-term debt of bonds will be listed under this account; for example, any debt that is coming due for the current year will be on this line item.

It may also refer to short-term debt; again, there is no uniformity in the labeling of accounts, which can lead to some confusion.

Microsoft lists the current portion of long-term debt as $2,749 million.

Deferred revenue

The company lists this item as short-term unearned revenue on Microsoft’s balance sheet.

Consider it revenue the company has earned but not recognized as the sale has not been finalized according to accounting rules.

Microsoft lists short-term unearned revenue as $45,538 million on its balance sheet.

Non-current Liabilities

The non-current liabilities are longer-term liabilities having longer maturities over a year. Any long-term debt is listed under this line item and is a major source of investigation for investors.

Long-term debt

This account includes any long-term debt, except the current portion due if listed under the current liabilities. The long-term debt gets paid on a debt schedule, which outlines all of the company’s debt and indicates the schedule of payments, along with the interest expense, total debt due, and the schedule of the principal payments.

All information regarding long-term debt is listed under the notes section of the financial reports. Here, you will find everything you wish to know about the company’s long-term debt.

In the notes section, we find the schedule for debt repayment; this item can help you determine how much debt the company owes and when the debt comes due on a cash flow basis.

Microsoft lists long-term debt of $47,032 on the balance sheet.

Long-term income taxes

This account lists the unpaid or carrying amount of income taxes due for longer than one year—also known as income taxes payable.

Microsoft records this item as $26,069 million on its balance sheet.

With that, we will wrap up our summary of the liabilities section of the balance sheet.

To ensure our balance sheet balances, the shareholders’ equity section must equal the difference between the assets and liabilities.

So far, Microsoft has:

• Total Assets – $364,840 million
• Total Liabilities – $198,298 million

Equity Side of Equation

Also referred to as shareholders’ equity or stockholders’ equity, we have the owners’ claims on any assets after paying the debts. Think of it as the percentage of ownership of any assets left over after paying the debt owed on those assets.

Equity is equal to the firm’s assets minus the liabilities .

Shareholders’ equity can be positive or negative , depending on whether the company has more or fewer assets than liabilities.

If the company owes more liabilities than assets, its equity will be negative. Many investors, including yours, consider negative equity a risky proposition because it means the company owes more money than assets created for the company.

Share Capital

The share capital line item indicates the amount of money shareholders have invested in the company. Owners made this initial contribution when the company was first created.

They are also known as shareholders’ capital, equity capital, or common stock.

Microsoft lists this line item as $86,939 million on its balance sheet.

Retained Earnings

Retained earnings are the total amount of earnings that the company decides to keep after paying share repurchases, dividends, or paying down debt.

Every quarter, the company decides what to do with its earnings, whether it wants to return money to shareholders, pay down debt, or reinvest in projects to grow the company.

Any amount used to pay dividends, for example, is deducted from retained earnings, and any money left over is added to retained earnings.

Keep in mind that this is not an actual bank account but an accounting ledger that indicates how much it has to use for dividend payments, for example. The actual payment of dividends comes from the statement of cash flows, which is the business’s checking account.

We can find more information concerning the retained earnings in the stockholders’ equity statements, which also contain all the information regarding all items related to shareholders’ equity. That statement can give you more details on the dividend payments for the company, for example.

The retained earnings for Microsoft were $84,281 million for 2022.

That wraps up our summary of the shareholders’ equity section of the balance sheet.

To balance our statement, the shareholders’ equity section equals $166,542.

All of the sections then equal the following amounts:

• Total Assets – $364,840
• Liabilities – $198,298
• Shareholders’ Equity – $165,542

Liabilities ($198,298) + Equity ($166,542) = $364,840

Final Thoughts

Analyzing the balance sheet can give you great insight into the financial health of any company. Many investors focus on the balance sheets of businesses they buy because the balance sheet can tell you how strong the company is in the event of a downturn in the market.

Given the current condition of the stock market, studying balance sheets is paramount to determining the liquidity of businesses. Please think of the balance sheet as the financial statement that tells you how much money the company has on hand to create more assets, how much those assets will cost, and how much equity the company is worth.

Many metrics are associated with the balance sheet to help determine the strength and health of the company. Among them are:

• Return on Assets
• Return on Equity
• Return on Invested Capital
• Current Ratio
• Quick Ratio
• Debt to Equity
• Debt to Assets
• Asset Turnover Ratio

Learning the balance sheet structure and language of the line items and studying the balance sheet utilizing the above-referenced metrics and ratios can help you learn a lot about a company’s financial strength.

That is going to wrap up our discussion on the balance sheet structure.

As always, thank you for taking the time to read this post, and I hope you find something of value on your investing journey.

If I can further assist, please don’t hesitate to reach out.

Until next time, take care and be safe out there,

Dave, a self-taught investor, empowers investors to start investing by demystifying the stock market.

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Difference between Horizontal and Vertical Balance sheet

Difference between Equity Share and Preference share

The Difference Between Horizontal and Vertical Balance sheets is of presentation. In the horizontal balance sheet, the assets and liabilities are shown side by side but in the vertical balance sheet, the assets and liabilities are shown from top to bottom. The full meaning is explained in this article.

The whole presentation of both types of presentation is already explained in the following article: –

Balance Sheet: Meaning, Format & Examples

What is the Horizontal form of the Balance sheet:

In this form of presentation of the balance sheet, we have to present all account information across the page from left to right. All assets are shown on the corresponding side of all liabilities. All liabilities are shown on the left side of the balance sheet and all assets are shown on the right side of the balance sheet. 

There is also two way to sort the accounts of assets and liabilities, these are shown as following: –

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• Based on Liquidity 
• Based on Permanence 

What is the Verticals form of the Balance sheet:

In the vertical form of the presentation of the balance sheet, we have to present all account information across the page from top to bottom. First, we show all liabilities and capital and then after all assets. All assets are shown after all liabilities.

• Based on Permanence

Chart of Difference between Horizontal and Vertical Balance sheet: –

Download the chart in PNG and PDF:-

If you want to download the chart please download the following image and PDF file:-

Conclusion:

Thus, both terms have the only main difference of presentation of the accounts of assets, liabilities, and capital. One is prepared side by side and another is prepared from top to bottom. 

Thanks for reading the topic.

p lease comment your feedback whatever you want. If you have any questions please ask us by commenting.

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Difference between Equity share and Preference share

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Vertical Balance Sheet

Business, Legal & Accounting Glossary

• Define: Vertical Balance Sheet

Definition: Vertical Balance Sheet

Full Definition of Vertical Balance Sheet

A vertical balance sheet is one in which the balance sheet presentation format is a single column of numbers, starting with asset line items, then liability line items, and finally shareholders’ equity line items. Line items are presented in decreasing order of liquidity within each of these categories. As a result, the presentation within the topmost block of line items (for assets) usually starts with cash and ends with fixed assets (which are much less liquid than cash) or goodwill. Similarly, for the same reason, the liabilities section begins with accounts payable and usually ends with long-term debt.

The purpose of a vertical balance sheet is to allow the reader to compare the numbers on the balance sheet for a single period. For example, to estimate a company’s liquidity as of the balance sheet date, someone might compare the current assets total to the current liabilities total.

The Difference Between a Vertical and Horizontal Balance Sheet

The only alternative to the vertical balance sheet format is the horizontal balance sheet, which displays assets first and liabilities and shareholders’ equity second. Each column’s totals should always be the same in this style.

The vertical balance sheet format is significantly more popular than the horizontal balance sheet style because it allows for the presentation of several balance sheets on a single page, employing a side-by-side presentation arrangement that may span a large number of reporting periods.

To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.

Definition Sources

Definitions for Vertical Balance Sheet are sourced/syndicated and enhanced from:

• A Dictionary of Economics (Oxford Quick Reference)
• Oxford Dictionary Of Accounting
• Oxford Dictionary Of Business & Management

This glossary post was last updated: 20th April, 2022 | 0 Views.

How to Read a Balance Sheet

Evaluating a company's financial health using the balance sheet

How to Read a Balance Sheet?

Reading a balance sheet is important in determining the financial health of a company. The balance sheet, also known as the statement of financial position, is one of the three key financial statements. It summarizes a company’s financial position at a point in time. The balance sheet is unlike the other key financial statements that represent the flow of money through various accounts across a period of time.

The balance sheet is often considered the most important of the three statements, as it can be used to determine the health and durability of a business. For example, when doing credit analysis , a lender studies the strength of the balance sheet before determining if the cash flows are enough to service the debt. Hence, there is a constant focus on maintaining a strong and healthy balance sheet.

The next sections describe the structure of the balance sheet and how to read different parts of the balance sheet. They also discuss the important relationships between the other statements and the balance sheet, as well as how to read the notes.

Structure of the Balance Sheet

The balance sheet has four major sections – Assets, Liabilities, Shareholder’s Equity , and Notes. Each of the first three sections contains the balances of the various accounts under each heading. The notes section contains detailed qualitative information and assumptions made during the preparation of the balance sheet.

More details about the structure of the balance sheet and its relationship to the other financial statements can be found in the free CFI course on Reading Financial Statements .

The assets section of the balance sheet contains the asset accounts of the business. They are accounts that lead to the generation of future cash inflows like accounts receivable or are used in the business like property, plant, and equipment (PP&E). The section is further subdivided into two parts – Current Assets and Non-Current Assets.

Current Assets : These are assets with an accounting life of less than one year. They include accounts like accounts receivable, inventory, cash and cash equivalents, and advances. The current assets form the basis of the working capital of the company. The current assets section is often reviewed in conjunction with the current liabilities section of the balance sheet.

While reading the current assets section of the balance sheet, it is important to check for asset overstatement, such as large accounts receivable due to an improper allowance for doubtful accounts. Further quality of assets cannot be directly determined using the balance sheet alone.

Continuing with the accounts receivable example, the quality of receivables can often be found in the notes to the balance sheet, which breaks down the receivables by age and credit quality. Older receivables are likely to turn into bad debts.

The following metrics can be used to analyze the current assets of a company:

• Days Sales Outstanding
• Current Ratio

Non-Current Assets : These are assets with a useful life of more than one year. They include accounts like the property, plant equipment, land, goodwill. They are the company’s assets that are used to generate revenues and drive the primary business activity. It is important to read the non-current assets section in relation to the notes and the income statement.

For example, the section includes property, plant, and equipment, which must be read in conjunction with notes about the depreciation policy. The notes to the balance sheet, as well as the cash flow statement, also detail the changes in fixed assets like PP&E. The changes are not clearly reflected in the balance sheet. The notes may also detail the breakdown of assets in the PP&E account and their useful lives.

Goodwill is often a large portion of the total assets of a firm. It is an intangible asset that arises primarily from acquisitions. Goodwill is checked for impairment every year and is written-off when it is no longer valuable. Details about the value of goodwill and its components are listed in the notes to the balance sheet. Since goodwill impairment is a value judgment, it is important to read the goodwill with notes section of the balance sheet.

The following metrics can be used to analyze non-current assets:

• Asset Turnover Ratio
• Capital Expenditure Ratio

2. Liabilities

The liabilities section of the balance sheet contains the liability accounts of the business. These are the obligations of the business to outside parties that arise from usual business operations and financing activities. This section is also divided into two subsections – Current Liabilities and Non-Current Liabilities.

Current Liabilities : These are liabilities that are due in less than a year. The current liabilities section contains accounts like accounts payable, unearned income, current portion of long-term debt. The section is read in conjunction with the current assets section of the balance sheet.

Current liabilities form the other end of the working capital of the business. They are the obligations that must be met using the cash flows from the current assets and other funding sources. While reading the balance sheet, it is important to study the company’s short-term obligations to check for any liquidity issues that may arise in the near term.

The following metrics can be used to analyze the current liabilities of a company:

• Days Payable Outstanding
• Quick Ratio

Non-Current Liabilities : These are liabilities with an accounting life of more than one year. Typically, the non-current liabilities section includes items such as long-term debt, lease obligations. The section is important, as it forms one part of a company’s capital structure and is essential in major analyses, such as valuation and credit analysis.

The section’s most important part is long-term debt. The long-term debt number on the balance sheet is an aggregate number, which pools all the debt issued by the company. The details of the figure are found in the notes section, which breaks down the debt by issuance. The note provides important details like maturity, interest rate, and other terms of debt. The information is essential to evaluate the capital structure and perform credit analysis if new debt needs to be issued.

Following metrics can be used to analyze non-current liabilities:

• Debt-to-Equity Ratio
• Debt-to-Capital Ratio

3. Shareholder’s Equity

The final major section of the balance sheet is shareholder’s equity. This section summarizes the value that accrues to the equity holders in the business. It includes accounts such as paid-up capital via different classes of stock like common stock and preferred stock, retained earnings, accumulated other comprehensive income, contributed surplus, etc.

The shareholder’s equity section is essential from the point of view of valuation. Often, financial statements will include a separate statement detailing the changes in shareholder equity. The paid-up capital is usually the largest item here. It is the amount raised from equity holders by issuing shares in the business.

The other items of importance are retained earnings and other comprehensive income. Retained earnings are the portion of the net income retained in the business for future use after the distribution of dividends. Another comprehensive income is the income generated from a source not directly related to the primary business activity. A typical example of such income is the income generated from hedging activities and other financial instruments.

Other comprehensive income is not the most transparent figure. It is important to dig deeper into the figure as well. Many of the financial instruments that contribute to other income are not listed on the balance sheet. They are instead described in the notes. It is important to understand the details of such financial exposures, as many of the instruments are complex, and the balance sheet number is often based on modeling assumptions.

The price-to-book ratio is a metric that can be used to analyze the shareholders’ equity section.

Case Study: Western Product Forests (WEF)

The following is an example of analyzing a real-world balance sheet. The data comes from the financial statements of Western Forest Products (WEF), a lumber company based out of British Columbia, Canada. The analysis that follows goes over the important accounts on the balance sheet and presents a quantitative analysis that can help measure the quality of the balance sheet in a way that makes it comparable to the balance sheets of other companies.

Some of the relevant accounts for Western Forest Products are discussed below.

WEF is in the business of selling lumber, which means that most of its revenues are driven by the value of the lumber they sell. Hence it is important to read the details of how they carry their inventory. According to the balance sheet notes, the inventory is carried at the lower of cost and net realizable value (NRV) .

Since timber is an actively traded commodity, it comes with an observable price that can be used to value the inventory. The above information also highlights one of the major risks of the business that the revenue is sensitive to market movements. The notes also give the breakdown of the inventory as illustrated in the table below:

Trade Receivables

Receivables form an important part of WEF’s balance sheet, as they represent sources of cash flow. The cash flow is necessary to meet the company’s short-term obligations. Though the balance sheet does not include an exclusive note for receivables, the note regarding financial instruments gives a breakdown of receivables by age. Based on the note, only about 3.5% of receivables in 2019 were late, which indicates the high quality of receivables.

Biological Assets

The biological assets section is the most unique item in the balance sheet of WEF. Biological assets are the forest land owned by the company for timber production. The asset is carried at fair value on the balance sheet, which means that number is subjective. It is important, and its valuation details are covered in the notes. The details can be a useful guide to revaluing the assets during analysis.

WEF carries a long-term debt of about $114 million on its books. The nature of the long-term debt is again made clear in the notes. According to the notes, the company drew from a $250 million credit facility.

Furthermore, the interest rate on the debt is 5.45%, which is higher than the 4.56% rate in the previous year. It indicates increased credit risk in the business, which is clearly evident from the increased debt-to-capital ratio.

• Quantitative Analysis

A detailed reading of the balance sheet is incomplete without quantitative analysis. Ratio analysis of the balance sheet is a good first step in determining the health of the underlying business. Ratio analysis can then be augmented with more complex analyses like the Altman Z-Score . The analysis goes over various sections of WEF’s balance sheet and performs suitable analyses.

According to the analysis, there was a deterioration in business performance in 2019. It is reflected by changes in the following list of ratios:

• The quick ratio declined from 1.13x in 2017 to 0.87x in 2019, which indicates liquidity stress. Typically, a good quick ratio is at least 1.0x. Also, note the current ratio is much stronger and is indicative of a good liquidity position. Hence it is important to use multiple ratios to analyze the same variable.
• Debt-to-Capital : The share of debt increased from less than 1% to 20%. The debt is not related to investment but to meet the business’s funding requirements, indicating weak revenue and profits.
• Cash Ratio : There is also a sharp decline in the cash ratio from 0.33x to a mere 0.04x. It implies that the company might encounter issues in meeting its short-term obligations.

Finally, the Altman Z-Score can be used as a summary figure for the quality of the balance sheet. In 2019, it fell to 1.93 from a health score of 3.67. The figure indicates the company is borderline bankrupt and is clearly a distressed business, according to the Z-Score analysis. The following table summarizes the results of the analysis:

More Resources

To keep learning and developing your knowledge base, please explore the additional relevant resources below:

• Analysis of Financial Statements
• Financial Statement Notes
• Projecting Balance Sheet Line Items
• See all accounting resources
• See all capital markets resources

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Basic College Accounting

Format Of The Vertical Presentation Of Balance Sheet

See article on advantages and disadvantages of using the vertical presentation method

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