Balance Sheet is the financial statement of a company which includes assets, liabilities, equity capital, total debt, etc. at a point in time. Balance sheet includes assets on one side, and liabilities on the other. For the balance sheet to reflect the true picture, both heads (liabilities & assets) should tally (Assets = Liabilities + Equity).
Description: Balance sheet is more like a snapshot of the financial position of a company at a specified time, usually calculated after every quarter, six months or one year. Balance Sheet has two main heads –assets and liabilities.
Let’s understand each one of them. What are assets? Assets are those resources or things which the company owns. They can be divided into current as well as non-current assets or long term assets.
Liabilities on are debts or obligations of a company. It is the amount that the company owes to its creditors. Liabilities can be divided into current liabilities and long term liabilities.
Another important head in the balance sheet is shareholder or owner’s equity. Assets are equal to total liabilities and owners’ equity. Owner’s equity is used when the company is a sole proprietorship and shareholders’ equity is used when the company is a corporation. It is also known as book value of the company.
Let’s understand reporting of a transaction on a balance sheet. If a company XYZ takes a five-year loan from public sector banks for an amount of Rs 5,00,000, it means that the bank will pay the money to XYZ Ltd.
The accounts department will increase the cash component by 5,00,000 on the assets front, and at the same time increase the long term debt account with the same amount, thus balancing both the sides.
If company raises Rs 10,00,000 from investors, then its assets will increase by that amount, as will its shareholder’s equity.
The balance sheet is the most important of the three main financial statements used to illustrate the financial health of a business. The other two are:
The Income Statement which shows net income for a specific period of time, such as a month, quarter, or year. Net income equals revenue minus expenses for the period.
The Cash Flow Statement which shows the movements of cash and cash equivalents in and out of the business. Chronic negative cash flows are symptomatic of troubled businesses.
Incorporated businesses are required to include balance sheets, income statements and cash flow statements in financial reports to shareholders and tax and regulatory authorities. Preparing balance sheets is useful for monitoring the health of the business.
An up-to-date and accurate balance sheet is essential for a business owner looking for additional debt or equity financing, or who wishes to analyse the business and needs to determine its net worth.
All accounts in your general ledger are categorized as an asset, a liability or equity.
The relationship between them is expressed in this equation:
Assets = Liabilities + Equity
The items listed on balance sheets vary from business to business depending on the industry, but in general, the balance sheet is divided into the following three sections:
Assets
As in the balance sheet example shown below, assets are typically organized into liquid assets — those that are cash or can be easily converted into cash within a period of 12 months and non-liquid assets that cannot quickly be converted to cash such as land, buildings and equipment.
The list of assets may also include intangible assets, which are much more difficult to value.
Generally accepted accounting principles (GAAP) guidelines only allow intangible assets to be listed on a balance sheet if they are acquired assets with a lifespan and a clearly identifiable fair market value (the probable price at which a willing buyer would buy the asset from a willing seller) that can be amortized. These are reported on the balance sheet at the original cost minus depreciation.
Liabilities
Liabilities are funds owed by the business and are broken down into current and long-term categories. Current liabilities are those due within one year and include items such as:
Accounts payable (supplier invoices)
Wages
Income tax provisions
Customer deposits (advance payments for goods or services to be delivered)
Utilities
Temporary loans, lines of credit or overdrafts
Interest
Maturing debt
Sales tax and/or goods and services tax charged on purchases
Long-term liabilities are any that are due after a one-year period. These may include deferred tax liabilities, any long-term debt such as interest and principal on bonds, and any pension fund liabilities.
Equity/Earnings
Equity, also known as shareholders’ equity, is that which remains after subtracting the liabilities from the assets. Retained earnings are earnings retained by the corporation — that is, not paid to shareholders in the form of dividends.
Retained earnings are used to pay down debt or are otherwise reinvested in the business to take advantage of growth opportunities.
While a business is in a growth phase, retained earnings are typically used to fund expansion rather than paid out as dividends to shareholders.