Guide to the preparation of the reclassified balance sheet
The corporate bureaucracy is a skein of documents containing relatively hostile information. In fact, it is very easy that if you have ever been confronted with a balance sheet document, you have been more confused than satisfied.
All the more so if what you tried to decipher was the balance sheet. In fact, this document is, in all likelihood, the most complex of the files that are part of the financial statements.
Fear not, then, it is normal to feel lost. But, despite the obvious difficulty, it is still not the case to give yourself away. In fact, approaching and understanding financial statement documents is possible!
Through reclassification processes, in fact, it is possible to obtain simplified versions of the original documents, so that the necessary information can be accessed without too much headache. How? Let's look at it together.
What is a balance sheet?
First of all, to understand the meaning of a reclassified balance sheet, we need to make sure that we understand the concept of a balance sheet.
The balance sheet is an accounting document that, together with the income statement , the notes to the financial statements and the cash flow statement, forms the financial statements.
In terms of content, the balance sheet reports the set of assets and capital that a business has. It can be regarded as the account of a company's value in economic terms. In fact, the balance sheet corresponds to the component of the financial statements that allows one to define the capital structure and financial position of the given business.
It also makes it possible to show the relationship that exists between the investments made by the business and its sources of financing. Which is particularly important, as it enables the analysis of a company's liquidity and capital strength .
In the balance sheet, information is developed through the declaration of:
- The assets, which is what the company invests (shown in the left column on the document);
- The liabilities, which are the sources through which the company covers its assets (in the right column on the document).
The reclassified balance sheet
What it is.
The reclassified balance sheet is a document resulting from the reclassification of the balance sheet, that is, the process of reorganizing the information contained in this financial statement document.
Specifically, it aims to recast the values contained in the balance sheet. The objective is to highlight the nature of investments expressed in assets and the composition of financing sources reported in liabilities.
Ultimately, while the balance sheet is developed more to meet civic needs, its reclassification serves to fill more strictly business needs. In fact, the reclassified balance sheet is not a document that must be mandatorily prepared and filed, but is an analytical structure made by and for the business.
What is it for?
The purpose of the balance sheet reclassification process is to provide more approachable, clearer and easier information than the original content. This is done through a process of reworking the values in the balance sheet, which are reorganized and reformulated to be made more understandable.
The reclassified balance sheet is useful to the company because it provides a tool for analyzing company performance and progression. In this way, management can keep an eye on the dynamics of its business and, if necessary, implement strategic measures to make the right changes.
A step in the reclassification of the balance sheet
Balance sheet reclassification is a process that usually takes place within the process of reclassifying the annual financial statements. In fact, the balance sheet is itself a component of the financial statements and not a document that is prepared in its own right.
☝ The balance sheet is a formal record of a company's economic performance, starting with its sales figures and ending with its creditworthiness. Reclassification, on the other hand, is a financial statement analysis , which aims to transform the data contained in it into information that is easier to understand.
Balance sheet reclassification: how is it done?
In practice, balance sheet reclassification is done through the application of two main criteria . These differ according to business dynamics and, also, the information being sought. These criteria are:
- The financial criterion;
- The functional criterion.
Balance sheet reclassified using the financial criterion
In the process of reclassifying the balance sheet according to the financial criterion, assets and liabilities are divided according to:
- Degree of liquidity, that is, the tendency of values to become cash in the short term;
- Degree of collectability, that is, the expected timing of monetary disbursement, i.e., in a nutshell, the maturity by which the cash received must be repaid.
The values are, then, grouped into:
- Current assets/liabilities, i.e., time-current in nature. Assets are, in turn, broken down into other categories. These are: immediate assets, i.e., cash available from the company or banks, and deferred assets, i.e., provided by receivables collected over the next 12 months. Next, inventories are defined, corresponding to inventories.
- Consolidated, i.e., long-term assets/liabilities(e.g., fixed assets, which in turn are further divided into: tangible, intangible and financial).
The financial criterion is preferred when one is seeking information regarding the company's solvency. The latter refers to the company's ability to meet its obligations in the short and/or long term.
Following this reasoning, we infer that, in this type of analysis, the financial criterion places the time variable at the center of the investigation. In fact, the main purpose of this type of reclassification is to understand:
→ How long it will take the assets to become liquid. Will this be before or after the fiscal year (usually corresponding to the time frame of one year)?
→ How long will liabilities take to settle? Will this occur before or after the fiscal year?
Balance sheet reclassified using the functional criterion
The balance sheet reclassified using the functional criterion, on the other hand, provides a breakdown of assets and liabilities based on the relevant management area. This means that the focus is placed on the purpose or function of assets and liabilities.
The reorganization of balance sheet values takes place, this time, independently of maturities, but on the basis of their relationship to the purchase-production-sale cycle. Specifically, the analysis is done by dividing assets and liabilities into:
- Current, referring to the uses that take place on a regular basis, repeated with the succession of production cycles.
- Non-current, referring to the uses that are not recurrent and do not take place on a regular basis.
The functional criterion is useful if one is seeking information on the soundness of the company, that is, the composition of the company's assets. Specifically, this type of analysis provides information on the degree to which the company's own assets are determined (by own production or by aspects external to the company).
Template to download
Now it's your turn!
If you are looking for a way in which you can immediately put into practice the notions you have just learned, we recommend that you
to prepare your reclassified balance sheet. This will enable you to carry out the reorganization of your business values related to the balance sheet in a guided way and without wasting time.
Are you ready? Good luck!
Article translated from Italian