Definition of balance sheet
A balance sheet can be defined as a financial statement of a company or an organization that contains liabilities, assets, and capital owned by the organization. The balance sheet mainly mentions the income of the company and its expenditure at a particular point in time.
What is a balance sheet?
A balance sheet is a financial statement of a company that provides details about the assets, liabilities, and equity owned by the organization at a particular point in time. In simple words, it can be said that a balance sheet gives details about the total net worth of your business.
The financial details from the past are also mentioned in the balance sheet. So that it is easy for the reader of the balance sheet to make a comparison of the performance of the company in two consecutive years, this data can be used to track the performance of the company and to analyze what areas require improvement. In addition to this, this data can be used to build finances for the company.
You can also refer to your balance sheet to learn about how you can fulfill your financial obligations as well as find out the best methods to make the use of your credit to finance your business operations.
There are a total of three types of financial statements that are prepared by an organization to keep track of the financial health of the company. However, the balance sheet holds the most important position among all the other financial statements. The other two financial statements can be defined as the following.
The cash flow statement
The income statement
The income statement shows the total income of an organization for a specific period, such as for a month, a quarter, half-yearly, or annually. The net or overall income of an organization is equal to the total revenue generated by the organization, minus the total expenses made by it.
Businesses are required to include all financial statements such as cash flow statements, income statements, and balance sheets in the financial reports to be presented to the shareholders, investors, and tax and regulatory authorities.
However, a sole proprietorship and partnership businesses don’t need to generate a balance sheet. However, a balance sheet is useful when it comes to monitoring the financial health of the company continually.
It is crucial for a person in the business to create an accurate and up-to-date balance sheet when he is looking for additional debt or equity financing for his business. Similarly, a businessman who wishes to sell his business or wishes to learn about the net worth of business is required to maintain an up-to-date balance sheet.
The formula used to create a balance sheet
A balance sheet is formed based on the simple formula where assets are kept on one side, and the shareholders’ equity & total liabilities of the business are kept on the other side.
Assets = Shareholders’ equity + Liabilities
The formula is quite simple as a company is required to pay for the things that it owns, such as assets either by borrowing the money or by acquiring it from the shareholders or investors.
What is on a balance sheet?
A balance sheet can be referred to as a snapshot of the financial state of a company at a specific point in time. A balance sheet does not provide any information about the trends that are taking place in the business for a more extended period. Because of this reason, a current balance sheet is not sufficient to learn about the financial health of the company. Along with other financial statements, the balance sheet of previous fiscal periods should also be considered for comparison. A balance sheet should also be compared with the other businesses that are part of the same industry because different industries use different methods to finance companies.
The investors derive different ratios such as debt to equity ratio, the acid-test ratio from the balance sheet to learn about the financial health of the company. A balance sheet contains all critical financial aspects of the company that is important to know to learn about the financial health of the company.
Let us learn about the content of a balance sheet.
In the assets segment, assets are mentioned from top to down based on their ease of conversion into cash. These assets can be converted into current assets or non-current assets. Existing assets are those assets that can be converted into cash within a year or less than a year. On the other hand, non-current assets are those assets that can’t be converted into cash within a year. Because of this, these assets are also referred to as long-term assets.
The following are the general assets that are mentioned in a balance sheet.
Cash and equivalents
The cash and equivalents are the most liquid assets. Therefore, they appear on the first line of the balance sheet. Cash equivalents are also considered as part of this type of current asset as they usually have short-term maturities, i.e., less than three months or these can be assets that a company can liquidate on short notice.
Marketable securities are considered as cash equivalents as they can be liquidated at short notice.
Inventory consists of all the raw material, work in progress goods, and finished products available in the market. The inventory is also considered as current assets as these goods are always available for the sales. IN the income statement, it is mentioned under the “cost of goods sold.”
Account receivables consist of the money that a company will get from its customers. However, doubtful accounts of specific customers are considered under allowance as it is uncertain whether these customers will pay or not.
Prepaid expenses are those expenses that have already been paid for. The examples of prepaid expenses are advertising contracts, insurance, and rents, etc.
Non-current assets are those assets that can’t be liquidated at short notice. Therefore, the non-current assets are also referred to as long-term assets. The following are the examples of non-current assets that are part of a balance sheet.
Plant, property, and equipment or fixed assets
The plant, property, and equipment are the non-current assets of an organization. These assets are also known as tangible fixed assets. The cost of these assets noted as net cost after minus their depreciation cost.
These assets include machinery, land, equipment, or other capital intensive assets.
Intangible assets are also known as non-physical assets. For example, intellectual properties and goodwill are intangible assets. The intangible assets are mentioned on the balance sheet only if they are acquired and are not built within the organization.
Intangible assets can be assets that can be identified or can’t be identifiable. Examples of identifiable assets are licenses, secret formulas, and patents, etc. on the other hand, the examples of unidentifiable assets are goodwill and brand image of the company.
Long-term investments are those investments that can’t be liquidated within a year or in the coming year.
Liabilities are the debts or money owed by the company to the outside parties. The examples of liabilities are rent, utilities, salaries, bills, and interest paid on the bonds, etc. Liabilities can also be of two types, i.e., current liabilities and non-current liabilities.
Current liabilities are those liabilities of the business that are due within a year or the liabilities that a company is required to pay in a short period.
Rent, tax, utilities
These are the most basic forms of current liabilities. The company is required to pay rent of the building and business taxes in a short period.
Current portion of long-term debt
The current part of long-term debt is a piece of debt that the business is required to pay within a year. For example, if a company has taken a loan which it is necessary to pay back in 5 years, but the monthly or annual installment that the business is required to pay will be considered as a current liability.
- Interest payable
- Bank indebtedness
- Earned and unearned premiums
- Customer prepayments
- Wage payments
- Dividends payable
Non-current liabilities are those liabilities that are not due within a year. The following are examples of non-current liabilities.
1. Long-term debt
It is a debt that the company is required to pay back in a long time. For example, interest and principal paid on the bonds issued by the company.
2. Pension fund liability
Pension fund liability is the money the company is required to put into the accounts of its employees in the form of pension after their retirement from work.
3. Deferred tax liability
Deferred tax liability is the tax that has been accrued but is not required to be paid immediately.
The liabilities that are mentioned here are the liabilities that will appear on the balance sheet. But there are several other liabilities of an organization that are not needed to be mentioned on the balance sheet.
Shareholders’ equity is the money which is accredited to the business owners or shareholders.
The following are examples of shareholders’ equity.
1. Retained earnings
Retained earnings are the total income out of the net income of the company that the company decides to keep. At the end of every financial year, the company might pay off its debts or reinvest the money earned. The remaining money left after these payments is referred to as retained earnings.
2. Share capital
Share capital is the total value of funds that are invested in the company. At the beginning of the company, the cash is put in by the shareholders of the company.