Balance Sheet – Definition and Explanation

 

A statement giving a clear picture of the net worth of a business is known as a balance sheet. A balance sheet is a financial tool for all companies to list their assets, liabilities, and owner’s equity to calculate the actual worth of the business. Creating a financial statement is standard practice for all businesses. Governing agencies later audit these statements for taxes and other purposes. The commonly used financial statements of a company include the following.

• Income statement:

An income sheet covers sales, cost of goods sold, expenses, net income, taxes, and earnings per share. It creates annually, half-yearly or quarterly.

• Balance sheet:

A balance sheet displays a snapshot of the net worth of the business. It is at the year-end and the date specifies on the balance sheet.

• Cash flow statement:

A cash flow statement merges both above information to display the utilization of the cash in three main business activities, including:

1. Operating activities
2. Financial activities
3. Investing activities

What is a balance sheet?

A balance sheet is a financial statement that consists of the balances of multiple different ledger accounts. This bookkeeping method helps list the ledger balances in the below-mentioned categories so that a company can get an idea of its financial position. These categories are:

• Assets:

Assets are all properties/belongings/things owned by the business. They can include the properties, cash, machinery, and even prepaid expenses.

• Liabilities:

The liabilities of a business include regular dues, which the company is supposed to clear in the coming days or years. They have long-term loans, short-term loans, and an accrued account of the business.

• Owner’s equity:

The owner’s equity is the capital of the owner who invested in the business. It includes the retained earnings and finances generated from issuing stocks and debentures.

Therefore, a balance sheet can define as “A statement which consists of assets, liabilities and owner’s equity (capital) on a particular date.” The balance sheet got its name as the closing balance at the year-end.

Components of a balance sheet

Types of assets 

1. 1. Real assets
   2. Fixed assets
   3. Tangible assets
      1. Building
      2. Plant
      3. Fixture and fittings
      4. Furniture
      5. Machinery and vehicles
   4. Intangible assets
      1. Goodwill
      2. Patent rights
      3. Trademarks
   5. Current assets
   6. Quick assets
      1. Stock debtor
      2. Cash
      3. Cash at bank
   7. Floating assets: which keep on converting from one form to another, such as:
      1. On the sale of goods, the inventory changes into debtors
      2. On purchase of goods, cash converts into inventories
   8. Fictitious assets
      1. Preliminary expenses
      2. Loss on the issue of shares

Types of liabilities

1. 1. Fixed liabilities
      1. Debentures
      2. Long-term loans
   2. Current liabilities
   3. Deferred liabilities: The payback period is less than a year and more than a month
      1. Short term loans
   4. Quick penalties: The payback period is within a month
      1. Bank overdraft
      2. Outstanding expenses
      3. Creditors
   5. Equity or internal liabilities
      1. Reserves
      2. Owner’s equity
      3. Share’s capital
   6. Retained earnings

Features of a balance sheet

1. The balance sheet is the final stage of the financial accounts in bookkeeping records.
2. It prepares at the year-end.
3. It is just a statement, not a ledger account.
4. The balance sheet has two sides which show the assets on the left side and liabilities on the right side.
5. Both the right and left sides of a balance sheet should always balance.
6. The balance sheet only reflects the balances of the asset accounts and liability accounts. They do not reflect revenue accounts.
7. The balance sheet also reflects the business’s solvency.
8. The balance sheet is designed after the income statement as it requires the net profit or net loss in the equity section.

Why is a balance sheet crucial?

There are plenty of benefits to creating a balance sheet for your business. However, for smaller companies, the balance sheet is not an essential requirement as they are not opting for listing their businesses for stocks or they are paying huge taxes. Regardless, a balance sheet can be beneficial in reflecting the whole heart of your business.

1. It acts as a snapshot of the business’s financial health on a specific date
2. It helps you in expanding your business
3. Can help you get financial aid through investors or loans as your business performance and current health documents
4. Prioritizes your work, showing you all your liabilities that need your immediate attention
5. You can even generate financial ratios very quickly if you have an appropriately detailed balance sheet documented

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