A balance sheet, also known as a "statement of financial
position," reveals a company's assets, liabilities and owners' equity (net worth). The balance sheet, together with the income statement and cash flow statement, make up the cornerstone of any company's financial statements. If you are a shareholder of a company, it is important that you understand
how the balance sheet is structured, how to analyze it, and how to read it.
The balance sheet is divided into two parts that, based on the following equation, must equal each other or balance each other out. The main formula behind balance sheets is:
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Assets = Liabilities + Shareholders' Equity
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This means that assets, or
the means used to operate the company, are balanced by a company's financial
obligations, along with the equity investment brought into the company and its
retained earnings.
Assets are what a company
uses to operate its business, while its liabilities and equity are two sources
that support these assets. Owners' equity, referred to as shareholders' equity in a publicly traded company, is the
amount of money initially invested into the company plus any retained earnings and it represents a source of funding for
the business.
It is important to note
that a balance sheet is a snapshot of the company's financial position at a
single point in time.
SEE: Complete Guide To Corporate Finance, What Is A Cash Flow Statement? and Understanding The Income Statement
Know the Types of Assets
Current Assets
Current assets have a life
span of one year or less, meaning they can be converted easily into cash. Such
assets classes include cash and cash equivalents, accounts receivable, and inventory. Cash, the most fundamental of current assets, also includes non-restricted bank accounts and
checks. Cash equivalents are very safe assets that can be readily converted into cash; U.S. Treasuries are one such example. Accounts receivables consist of the short-term obligations owed to the
company by its clients. Companies often sell products or services to customers
on credit; these obligations are held in the current assets account until they
are paid off by the clients.
Lastly, inventory
represents the raw materials, work-in-progress goods, and the company's
finished goods. Depending on the company, the exact makeup of the inventory
account will differ. For example, a manufacturing firm will carry a large
amount of raw materials, while a retail firm caries none. The make-up of a
retailer's inventory typically consists of goods purchased from manufacturers
and wholesalers.
Non-Current Assets
Non-current assets are
assets that are not turned into cash easily, are expected to be turned into
cash within a year, and/or have a lifespan of more than a year. They can refer
to tangible assets such as machinery, computers, buildings, and
land. Non-current assets also can be intangible assets such as goodwill,
patents or copyright. While these assets are not physical in
nature, they are often the resources that can make or break a company - the
value of a brand name, for instance, should not be underestimated.
Depreciation is calculated and deducted from most of these
assets, which represents the economic cost of the asset over its useful life.
Learn the Different
Liabilities
On the other side of the
balance sheet are the liabilities. These are the financial obligations a
company owes to outside parties. Like assets, they can be both current and
long-term. Long-term liabilities are debts and other non-debt financial obligations,
which are due after a period of at least one year from the date of the balance
sheet. Current liabilities are the company's liabilities that will
come due, or must be paid, within one year. This includes both shorter-term
borrowings, such as accounts payables, along with the current portion of
longer-term borrowing, such as the latest interest payment on a 10-year loan.
Shareholders' Equity
Shareholders' equity is the
initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings
into the company (after taxes), these retained earnings will be transferred
from the income statement onto the balance sheet and into the
shareholder's equity account. This account represents a company's total net worth.
In order for the balance sheet to balance, total assets on one side have to
equal total liabilities plus
shareholders' equity on the other.
Read the Balance Sheet
Below is an example of a
balance sheet
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As you can see from the
balance sheet above, it is broken into two areas. Assets are on the top, and
below them are the company's liabilities and shareholders' equity. It is also
clear that this balance sheet is in balance where the value of the assets
equals the combined value of the liabilities and shareholders' equity. Another
interesting aspect of the balance sheet is how it is organized. The assets and
liabilities sections of the balance sheet are organized by how current the
account is. So for the asset side, the accounts are classified typically from
most liquid to least liquid. For the liabilities side, the accounts are
organized from short to long-term borrowings and other obligations.
With Thank & Regards,
Saji George Yohannan,
SGY Chartered Accountants,
Office 304,Khalid Al Attar Building, Khalid Bin Al
Waleed Road, Dubai.
Contact: +971 55 7397058 , +971 52 2977534.28 Views
Nice blog. As a part-time accountant, you'll play a crucial role in maintaining accurate financial records, managing accounts payable and receivable, preparing financial statements, and ensuring compliance with local regulations. With your expertise, our business can navigate financial challenges and make informed decisions to drive growth.
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