What is a Balance Sheet?

Introduction to balance sheets 

Balance sheets are a part of the financial statements a company prepares for the year. This financial statement helps us analyze how much a business is worth and how much assets and liabilities a business has.  Investors and other creditors and stakeholders require the balance sheet to assess the business. Other two main financial statements are income statement and the statement of cash flow. 

The balance sheet provides us with the financial position of a company’s financials at a given moment in time. It shows us what assets a business possesses, what liabilities it owes and how much money the company has left to be distributed amongst the owners or shareholders. Hence, a balance sheet is also called a ‘statement of financial position’. Balance sheet can be prepared at the end of any accounting period; depending on the company it can be monthly, quarterly, or annually.

The purpose of a balance sheet

The balance sheet portrays the company’s financial health ever since the company commenced. By taking one look at a balance sheet, you can figure out how much money has been invested in the business or how much debt a business has gathered over time. Companies keep a track of their current liabilities and current assets to meet short-term obligations. So ratios are also calculated through balance sheets. A financial ratio like debt to equity ratio, for example, which tells us how much debt can be paid off through the equity available, incase of unavailability of current assets. Current ratio tells us whether the company can meet dues within the next 12 months with the help of current assets. Business should compare their balance sheets overtime to see how much they have improved as a business and how far they have come and if the business is going well.

The accounting equation is how a balance sheet is prepared.

Assets = Liabilities + Owner’s Equity. 

Assets are shown on one side, liabilities plus equity shown on the other. The two sides should be balancing. Let’s take a look at all these categories. 

Assets are things that the business owns. Assets are anything that the business uses to generate money. Assets that are cash or can be sold or converted into cash in 12 months are called current assets. For example: money in a bank account, accounts receivable, inventory, prepaid expenses etc.

Long-term assets, on the other hand, are things that can’t be converted into cash within the next 12 months. For example: land & buildings, fixtures & fittings, machinery & equipment and intangible assets & long-term investments.

Liabilities are the debts you owe and are also short term and long term. Current liabilities are accounts payable, unpaid expenses, loans and taxes due within a year. Long-term liabilities are loans due in over a year and bonds and debentures.

Equity is the money your company holds. It is owner or shareholder’s equity. This is what belongs to the owners. For example: owner’s capital, private or public stock and retained earnings.