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Hidden Issues in Balance Sheets
Just one report in a financial statement, the balance sheet provides a snapshot of the financial condition of an entity as of a specific date. Users rely on the balance sheet as a means of evaluating a company's stability, investment potential, and creditworthiness, but it should not be accepted at face value. Increasingly, nonfinancial professionals are making recommendations based on the results of their analyses ' often accepting a balance sheet without question. Attorneys for creditors and debtors, and bankruptcy judges, are making recommendations or decisions based on only cursory consideration of potentially misleading balance sheets. Neglecting to delve into the issues more deeply can result in serious pitfalls ' and, ultimately, business decisions being made based on an inaccurate picture of the entity.
Balance sheets alone are of limited use. The amounts stated on a balance sheet represent the book values according to U.S. generally accepted accounting principles (GAAP) and not necessarily the fair market value (FMV), which is often of greater relevance. For example, the price of a parcel of land plus the cost to build the structure on it (the GAAP value) is not necessarily equal to the market price to purchase the combined finished project (the FMV).
Moreover, a financial statement user could look at the balance sheet on page 4 and mistakenly believe that the entity is worth $1 million, the value of the owner's equity. A balance sheet is not a valuation tool, however, and by itself it cannot provide an accurate measure of the value of an entity. Even if all the information is straightforward, understandable, and fairly presented, a balance sheet is not a good tool for determining the value of an entity.
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