The balance sheet is generally regarded as the statement of a company's financial position. Investors, creditors and company leaders often view it as the best depiction of the overall financial health and stability of a company. Investors use it to determine how stable a company is for investment whereas lenders want to know how safe issuing new loans to the company is.
Balance Sheet Basics
The balance sheet follows the standard accounting formula: assets equal liabilities plus owners' equity. It sets out all of the company's current and long-term assets, including cash and receivables and also shows all of the company's short- and long-term debt liabilities. The difference between the two is called owners' equity, which is the current equity the company has that technically belongs to its shareholders or owners. The balance sheet, income statement, statement of cash flows and statement of owners' equity are the four critical financial reporting statements used by for-profit companies.
General Lender Considerations
Lenders generally have three concerns when evaluating a company's request for additional loan funds. They want to know how safe lending money to the company is, how much money to lend and what interest rates and terms should apply. Lenders evaluate the totality of the balance sheet, often in relation to other financial statements, in resolving these concerns. Ultimately, if a loan is granted, the amount, rates and terms are determined based on the level of risk posed.
In looking over the assets portion of the balance sheet, the lender wants to see a strong cash and current account basis, which supports the ability of the company to meet its near-term repayment obligations. In the long run, the lender is also interested in asset turnover, how liquid the assets of the company are and that it can effectively generate cash. Lenders may compare the balances of accounts receivables and cash from one period to the next to determine if a company has a high accounts receivable turnover.
Lenders look at short- and long-term liabilities relative to other sources of funds and in comparison to assets. If a company is highly leveraged by debt already, it would not appear as capable of taking on additional debt. Another important comparison is cash balances to short-term liabilities. If cash can barely keep up with short-term debt, the company is in a dangerous position. Two simple leverage ratios are often used to evaluate the company's debt position. The debt ratio is the total debt divided by total assets. Debt-to-equity is total debt divided owners' equity. Both offer a quick and concise glimpse at the company's prospects for paying back a new loan.