Definition: what is a balance sheet analysis?
As part of the balance sheet analysis, meaningful key figures about its current and forecast situation are determined from the annual financial statements of a company. The key figures form the basis for business decisions in strategic and operational terms.
The balance sheet analysis is thus
- a process of information gathering and analysis
- with the aim of gaining knowledge about the current and future situation of the company
- gain in terms of income, assets and finances.
Purpose & goals of the balance sheet analysis
Imagine: You get into your dream car and drive off. But something is strange. Suddenly the engine starts to stutter. The tank is empty. And now the police are coming at you too! Only now do you notice that the instrument panel is missing. While you had the ability to control the car, you couldn’t tell if you were doing it the right way.
You would never get in a car like this, right? But what about your company? Are you just going to work on it and hope it all turns out well? With the help of the balance sheet analysis, you can assess the current situation of your company and make a prognosis for future development. You can counteract undesirable developments in good time. The balance sheet analysis is a powerful information and control instrument that you can use to keep your company on track.
Types of balance sheet analysis
According to HOWSMB, the balance sheet analysis should provide you with the right information. Therefore, you should first consider which question concerns you most with regard to your company: Do you want to know whether your company is working effectively and generating sufficient income? How is the financial situation? Can you afford the upcoming expenses? Or do you want to make the right decisions so that your company occupies a good position in the market in the long term? Depending on the objective, different methods of balance sheet analysis are available.
Economic balance sheet analysis
The economic balance sheet analysis considers the profitability of the company. Regardless of tax and commercial law influences, the profit or the financial surplus is considered over time or in relation to other entrepreneurial variables.
Financial balance sheet analysis
The financial balance sheet analysis, in contrast to the economic balance sheet analysis, does not consider the company’s success, but the company’s financial situation: How high is the share of external financing in the total assets? Can pending payments be made without any problems or is the company threatened with bankruptcy?
Horizontal balance sheet analysis
Balance sheet ratios usually represent ratios between different balance sheet items. The horizontal balance sheet analysis shows assets and liabilities , ie assets and debts, in relation to each other. This is useful, for example, if liquidity bottlenecks are to be avoided. In this case, the assets that can be liquidated in the short term are compared with the liabilities to be paid in the short term.
Vertical balance analysis
If, on the other hand, the assets are set in relation to one another, then mach speaks of a vertical balance sheet analysis. The same applies to the positions on the liabilities side of the balance sheet . The equity ratio – the proportion of total capital raised by the company’s own funds – is a key figure that is determined as part of vertical balance sheet analysis.
Internal balance sheet analysis
The internal balance sheet analysis aims to clearly map the company situation and to put entrepreneurial decisions on a well-founded basis. The internal balance sheet analysis is carried out by persons who have access to internal company information material. As a rule, the basis is formed by the tax balance sheet and all other components of the annual financial statements , such as the profit and loss account or the management report.
External balance sheet analysis
In contrast, people not belonging to the company, such as customers or suppliers, can only carry out an external balance sheet analysis. They are dependent on publicly available material such as the annual report or the published accounts.
Qualitative balance sheet analysis
The qualitative balance sheet analysis looks at the company’s verbal reporting instead of quantitative indicators. Among other things, the management report or the notes to the annual financial statements are used for this purpose.
Strategic balance sheet analysis
As part of the strategic balance sheet analysis, the success factors for future company growth are examined. This includes the company’s resources, in particular human capital and knowledge, profitability as well as market value and strategic positioning.
Balance sheet analysis in 4 steps
You will preferably analyze your annual financial statements in a four-stage process.
1. Balance reading
First, you get an overview of all available data – starting with the tax and commercial balance sheet, through the profit and loss account, to the annual report and management report. This will give you a first, rough impression of the situation your company is in.
2. Time comparison
Then you compare the figures of the current annual financial statements with those of previous years. In order to be able to recognize a trend, you should not only refer to the last balance sheet, but also look at the data for the past five years. Can you see medium-term sales growth? How have the profits developed?
3. Changeover & reclassifications
Especially when looking at the financial situation, it makes sense to differentiate between long-term, medium-term and short-term capital, and to make a corresponding breakdown for assets. To do this, you now organize the data on your balance sheet so that you have the best possible overview.
4. Formation of key figures
Now you can calculate meaningful key figures that show you at first glance at which point you have to intervene.
Small collection of formulas: the key figures of the balance sheet analysis
Equity x 100 / fixed assets = investment coverage in percent
Who owns the machines that you bought for your company? You or the bank you borrowed from? The asset coverage provides a statement about this. Your company is solidly financed when your asset coverage is 70 percent or more.
Equity x 100 / total capital = equity ratio in percent
The question of how independent you are from your lender can be seen from the equity ratio . The share of equity in the company’s total capital should be as high as possible. The lower the equity ratio, the greater the risk of over-indebtedness. In general, the equity component should not fall below 50 percent of the total capital.
Return on equity
Profit x 100 / Equity = Return on Equity
Do the profits you make with your company really justify the work? Or do you earn more if you simply invest your money in lucrative financial products? Return on equity answers this question . If this ratio exceeds the interest rate you would get from an alternative investment, you are on the right track.
Return on sales
Profit x 100 / sales = return on sales
Is there so much profit left over from your sales that your entrepreneurial activity is also worthwhile? Return on sales answers this question. If it is below 5 percent, you should tackle cost savings as soon as possible.
Annual surplus or annual deficit
+ increases in long-term provisions
– reductions in long-term provisions
= cash flow
The cash flow shows the financial surplus or the financial deficit from the previous period. It is an indicator of the economic strength of your company. Can you make investments on your own? Or is there a threat of bankruptcy?
Liquid (liquid) funds x 100 / short-term liabilities = 1st degree liquidity
(Liquid funds + short-term receivables) x 100 / short-term liabilities = 2nd degree liquidity
What will your company profit bring you if you can’t pay for the upcoming repair of your production facility? To prevent this from happening to you, check your first-degree liquidity regularly. If you’re between 10 and 30 percent here, you don’t have to worry. The liquidity of two degrees represents your solvency. It should not fall below 100 percent.
Key figure-oriented balance sheet analysis: assess key figures & interpretation
You now know various key figures. Now you have to evaluate them in terms of their message and assess your company’s situation accordingly. If in doubt, you can derive more from these key figures. From this you can draw more precise conclusions as to where you need to change something in your company. It also makes sense to compare your balance sheet figures with general guidelines. Like an early warning system , these numbers let you know whether your company could get into trouble in the future.
In this context, the golden rule of accounting and the golden rule of financing are also interesting :
- The golden rule of the balance sheet states that long-term assets should be financed over the long term.
- The golden rule of funding is that long-term assets should have a ratio of long-term liabilities that is less than 100 percent. In short: the long-term tied assets should fall short of the long-term capital raised. On the other hand, the funds to be liquidated in the short term, such as bank balances, cash balances and customer receivables, should always exceed the short-term liabilities, so that the company never runs the risk of bankruptcy.
Prepare balance sheet analyzes with Excel
Balance sheet analysis tool for calculating key figures in Excel
You do not need any special software for the balance sheet analysis. A spreadsheet program like Excel will do just fine. To do this, transfer the data from your annual financial statements into the fields provided in the Excel sheet. The formulas for calculating the individual key figures are stored in the spreadsheet. This is how Excel quickly throws you out the necessary information.
Your advantage: You can save the key figures and make a detailed comparison over time in the next year.
There are already numerous Excel templates on the market that you can adapt to your own information needs. However, you can also create an Excel worksheet yourself. As an alternative to Microsoft Excel, you can also use the spreadsheet program from Open Office, for example.