What is a Balance Sheet?
A balance sheet is one of the most important financial statements used to indicate the financial health of a company. It gives a statement on the assets, shareholder’s equity, and liabilities over a specific period. It also offers a snapshot of the amount invested by the owners and hints about a business’s worth at a given point.
A balance sheet can be referred to as the statement of net worth. It primarily assists analysts and business stakeholders in evaluating the overall financial position of an organization and its ability to meet its operating needs. You can use your company balance sheet to understand your financial obligations and to identify the best ways to use credit for financing your business operations. You can perform back to back comparison using the balance sheet of previous years to keep a tab on your performance.
- A balance sheet reports shareholder’s equity, liabilities, and assets of a business at a given point. It is one of the major financial statements utilized by business owners and accountants.
- A balance sheet of a company indicates its financial worth during the assessment period. It allows creditors to check what the company owes to third parties during a specific time frame.
- Having an updated and accurate balance sheet is crucial for a business looking for equity financing or additional debt.
What is on a balance sheet?
The major balance sheet components are assets, liabilities, and shareholder’s equity.
The assets section in a balance sheet indicates the assets owned by a company that can be converted into cash. A balance sheet lists assets in the order of liquidity. There are primarily two main categories of assets: Current assets and Cash and Cash equivalents. Current assets can be converted into cash easily within a year or less.
Cash and cash equivalents are your liquid assets including money, checks, and currency stored in your business’s savings accounts. The assets part on the balance sheet also includes marketable securities, inventory, accounts receivable, fixed assets, prepaid expenses, intangible assets, and long-term assets.
The next section of the balance sheet is all about the company’s liabilities. It is the money that a company owes to others including recurring expenses, various forms of debts, and loan repayments. These can further be categorized into long-term and current liabilities.
Current liabilities include taxes, utilities, rent, payroll, interest payments, and current payments towards long-term debts. Long term liabilities cover long term loans, pension fund liabilities, and income tax payments.
Shareholder’s equity refers to the amount generated by a business, any donated capital, and the amount put in by the owners or shareholders to fund the operations. The shareholder’s equity forms the net assets for any company. It is estimated using the following formula.
Stakeholder's Equity=Total Assets-Total Liabilities
Balancing a balance sheet
While creating a company balance sheet, it is crucial that you pay special attention to ensuring that it is always balanced. A balance sheet is categorized primarily into two sections. One side represents your assets and the other side shows shareholder’s equity and liabilities.
The total value of the assets on the sheet must be equal to the sum of equity and liabilities. It is only in this case a balance sheet is said to be balanced. The foundational balance sheet formula is as follows:
Why is a balance sheet important?
A balance sheet is a crucial financial statement for any business. A balance sheet analysis reveals the financial health of a company. You can look into your balance sheet in conjunction with other financial statements to get a better understanding of how your company is performing. Understanding balance sheets offer insights into the following parameters.
You can compare your current assets to the liabilities to get a clear understanding of the liquidity of your company or to learn how much cash is readily available to your company. It is crucial to have a buffer between the assets and liabilities to cover short-term financial obligations. The assets always need to be greater than your liabilities.
You can compare your income statement to the balance sheet to measure how efficiently you are using your assets. For instance, you can picture how well your company can utilize the assets for the generation of revenue.
A balance sheet also helps you to understand the amount of leverage your business has and also indicates the financial risk you are facing. You can compare the debts to the equity on your balance sheet for judging the leverage.
Types of balance sheet:
There are various types of balance sheet. Each kind includes varying balance sheet items.
Comparative balance sheet:
A comparative balance sheet is used for the evaluation of account balances at several points over a period of time. For instance, a company looking to present account information for a period of five years can utilize this kind of balance sheet. It displays end-of-year balances side-by-side for easy evaluation. This clearly indicates whether the net worth is increasing or the debt obligations are increasing over the defined period.
Classified & unclassified balance sheet:
A classified balance sheet includes subcategories of various accounts for easier evaluation. For instance, the assets can be separated based on whether they are fixed assets, intangible or current assets. Unclassified do not make use of subcategories. It instead lists major assets by liquidity with cash first followed by the listing of liabilities with current accounts payable. The subsequent liabilities are listed based on the governing due dates.
Sample balance sheet: Let us consider a sample balance sheet of ABC Inc. to better understand the company balance sheet format.
|ABC Inc. Balance Sheet|
|Assets||Liabilities & Shareholder's Equity|
|Current Assets||Current Liabilities|
|Cash & Cash Equivalents||₹2,00,000||Accounts payable||₹4,75,000|
|Total Current Assets||₹4,75,000||Total current liabilities||₹7,07,000|
|Property & Equipment||Long-term Debt||₹32,04,022|
|Buildings & Improvement||₹45,00,000||Total Liabilities||₹39,11,011|
|Other Assets||Common stock||₹19,00,000|
|Intangible assets||₹1,13,000||Retained earnings||₹25,40,500|
|Total Assets||₹87,06,000||Total Liabilities & Shareholder's Equity||₹87,05,000|
The importance of the balance sheet cannot be stressed enough. An updated and accurate balance sheet is crucial for any business looking for additional equity financing or debt. It helps both the company management and analysts in determining the net worth of a company. Any incorporated business is required to include income tax statements, balance sheets, and cash flow statements in its financial reports for regulatory authorities and for shareholders.