The Balance Sheet acts as one of the principal components of a financial statement. Balance sheets display an entity’s finances on a specific date. Surety bond underwriters thoroughly analyze a balance sheet to understand what kind of assets, liabilities, and equity a business has at a moment in time.
The entity’s assets appear on the left side of the balance sheet. Assets represent what an entity owns. Accountants consider liquid or easily-liquidated assets as current assets. Current assets include cash, marketable securities, accounts receivable, and inventory. Long term assets, such as property and equipment, are not as easily liquidated. For bonding purposes, underwriters focus more on current assets because sureties want to ensure their principals can quickly pay claims and remain solvent in worst case scenarios.
By contrast, the entity’s liabilities appear on the right side of the balance sheet. Current liabilities include notes payable to banks (credit card debt and interest), accounts payable, and taxes.
The difference between total assets and total liabilities equals shareholders’ equity. The shareholders’ equity appears on the right side of the balance sheet and usually underneath liabilities. Shareholders’ equity equals the amount of the entity’s investments and/or worth, and consists of three main parts: common stock, treasury stock, and retained earnings.
Common stock represents the entity’s investments owned by the entity’s investors. Treasury stock is repurchased stock of the company when a previous investor sold his or her shares back. Retained earnings represent earnings reinvested into the company for the purpose of growing the company. Instead of paying out all earnings in dividends, the company holds onto “retained earnings” as funds for the entity’s future. Underwriters look at retained earnings as a main indicator of commitment to financial growth and strength.
Many underwriters analyze balance sheets by applying ratios and other formulas. The most important components of these ratios and formulas are current assets and current liabilities. Subtracting current assets from current liabilities indicates how much cash the entity has on hand and indicates liquidity. The result of this formula is known as “working capital.” Additionally, underwriters look for a ratio of current assets to current liabilities to equal no less than 1.3. This ratio indicates acceptable liquidity.
Underwriters prefer balance sheets (and thus financial statements as a whole) prepared by independent Certified Public Accountants (CPA). When a CPA prepares an audited statement, the surety trusts the CPA’s opinion, research, methods, and thoroughness. Because a balance sheet represents only part of an audited financial statement, underwriters need to consider the other components as well, such as the income statement, statement of cash flows, statement of retained earnings, notes, schedules, and the auditor’s report. These other documents show gradual changes of an entity’s finances over a longer period of time instead of just a single day’s holdings.