In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business partnership, a corporation, private limited company or other organization such as Government or not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a “snapshot of a company’s financial condition”. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business’ calendar year.
It is basically a financial statement that gives a snapshot of the business’s position/standing on a given date. It is usually devised and prepared at the end of the year or quarter. A balance sheet presents a summary of the company’s assets, shareholder’s equity and liabilities. These three significant segments give investors and the company owners a quick overview of how much the company owns and what it owes. It also shows the amount that has been invested by the shareholders in the firm.
Simply put, it is a business statement that shows net worth of the company at a given time.
Balance Sheet Formula
This is the formula that is used to devise and balance this financial statement:
Assets = Liabilities + Shareholder’s Equity
Three Essentials of a Balance Sheet
As stated above, to prepare a balance sheet, the accountant must first divide the balance sheet into three segments; assets, liabilities and shareholder’s equity.
All assets of the company are recorded under the ‘Assets’ section of the sheet which is on the left hand side. Please note that these assets are listed as per their liquidity. For example, cash that is the most liquid form of assets and is listed at the top, followed by other assets.
Also, assets are divided into two categories, current and non-current. Current assets are those that can be easily converted into money in less than a year and non-current/long term assets are those which cannot be converted easily during the same time duration, such as fixed assets (equipment and land) and intangible assets like goodwill.
This is the money that a company has to pay back/owes to other parties such as suppliers and lenders. Under this section (which appears on the top right hand side of the sheet), current liabilities are listed first, followed by long-term liabilities. Current liabilities include bank indebtedness, rent, utilities, tax, dividends payable, wages payable and interest payable while long term liabilities include deferred tax liability and pension fund liability.
This section appears on the bottom of the balance sheet to the right, under the liabilities section. This shows the money that is attributable to the shareholders of the company.
Balance Sheet – How to Interpret It?
The best way to interpret a balance sheet is to compare it with previous balance sheets of the company and with other businesses operating in the industry. Also, you can use different financial ratios like acid test ratio and debt to equity ratio to check the health of the company and identify areas where you need to improve and focus more on, for the future.
- Balance sheet effects, bailout guarantees and financial crises – academic.oup.com [PDF]
- Systemic sudden stops: the relevance of balance-sheet effects and financial integration – www.nber.org [PDF]
- Balance-sheet contagion – pubs.aeaweb.org [PDF]
- On the balance sheet-based model of financial reporting – meridian.allenpress.com [PDF]
- Financial intermediary balance sheet management – www.annualreviews.org [PDF]
- Balance sheet versus earnings conservatism in Europe – www.tandfonline.com [PDF]
- Taxes and off-balance-sheet financing: research and development limited partnerships – www.jstor.org [PDF]
- Financial intermediaries and monetary economics – www.sciencedirect.com [PDF]