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A bank’s accounting credit on a balance sheet is done to analyze a business’s net worth and income or income potential. This type of analysis is useful in determining lending rates and loan terms and conditions. The process for valuing credit on a balance sheet is a basic accounting function performed by all financial institutions, accounting firms and businesses.
Valuing Credits on the Balance Sheet
Valuing credit and debits helps a bank determine the value of the business, which is useful when a business seeks capital or is looking to be sold to a potential investor or buyer. This valuation includes taking a look at tangible and intangible assets, property and real estate holdings as well as other non-liquid assets (those that can readily be turned into cash) as well as any non-traditional credits for such items as goodwill and trademarks or brand identity.
Looking at the Balance Sheet
The bank will look at the balance sheet of a business as a way to determine the credits for valuation. The balance sheet is divided into 3 main sections, assets, liabilities and net worth or owner’s equity. The assets of the business include those that are current, such as cash, long-term like interest on bonds owned and fixed. Fixed assets include those items such as property, plants and furniture that have a value that can be obtained if sold in the open market but that value typically depreciates over time.
Business Net Worth
The net worth of the business looks at any shareholder’s equity and other forms of net worth that determine the value of a business. A business’s net worth is derived as the difference between equity and liabilities. It is possible (although not fairly common) for a business to have a negative net worth. This situation can only occur when a business has far more debt than assets to offset the liability.
Clues on Profitability
Investors and buyers of a business look closely at the balance sheet for clues on the business past and future profitability. The way in which credits are valued on the balance sheet, particularly those that are non-cashed make a difference on the worth of a business. Banks use a standardized process called generally-accepted accounting principles (GAAP) in order to determine the proper valuation methods for a balance sheet that is universally accepted.
The valuing function done by a bank should match the same values that are performed by the accounting function of a business and any independent evaluator that looks at a business’s worth. Discrepancies can be worked out between the bank and the evaluator for a common understanding of a credits value or worth in order to derive a consistent value for a business that is useful for an investor or loan officer.
