The Objectives of a Classified Balance Sheet
As a tool for financial analysis, a classified balance sheet will furnish the business owner, company management, board of directors, stockholders and other external parties, a quick reference to determine the business entity’s overall financial profile, particularly its liquidity. In order to provide this information at a glance, it is important that the major components, namely Assets, Liabilities and Owner’s Equity/Stockholders’ Equity are subcategorized according to their fundamental accounting values.
Defining the subcategories of a classified balance sheet is a way of providing guidelines to attain the objectives of said financial report. This is to readily indicate liquidity and other valuation concerns. Fast and accurate data may be needed to determine, up to how much can be easily converted into cash as a going concern.
The principle of going concern relates to the ability of the business to operate continuously, using its current resources and without need for further capital infusion. Capital infusion if any will only be utilized for purposes of expansion or enhancement, to take advantage of the income-earning opportunities available. A business owner may want to determine if he still needs to infuse additional capital but will also have to consider where his capital investments are going. There will be greater interest in determining the rate and amount of returns on his investments.
The same is true for investors, particularly those who will be buying into common stocks. They are aware that the company’s creditors will have first priority over the business assets, before their shares can be repaid in case of liquidation proceedings. They need to know where most of the company’s funds go; if the company has available funds in excess of its working capital demand; or if much of the company’s earnings are only being used to pay off debts. Other areas of concern include overspending for construction of buildings and/or procurement of equipment, but with little to show for profits.
Lenders and creditors will share the same interest regarding the overall make-up of the company, and will also look into the proportion of the liquid assets against the outstanding debts, particularly those that will be due and demandable within a year. Analysis will also entail how much of the company’s supposed liquid assets are still carried as accounts receivable. A careful scrutiny can reveal whether these receivables often exceed the actual cash maintained, which can be indicative of poor collection efforts. Defining the subcategories for a classified balance sheet will help the less savvy reader, gain knowledge as to what accounts have significant effects regarding the overall financial conditions of a business or company.
Below are the definitions and descriptions for each balance sheet subcategory.