Listing a company's assets, liabilities and equity, the balance sheet is, along with income and cashflow statements, one of the three key financial statements a business must prepare.
The purpose of a balance sheet is to disclose a company’s financial health. It is a statement of the assets, liabilities, and capital of your business, at a given point in time, which details the balance of income and expenditure over the preceding period.
Simply put, a balance sheet is a snapshot depicting the assets your company controls and who owns them.
A balance sheet is laid out to show assets on one side and liabilities and owner’s equity on the other. The relationship of these three elements is expressed in the rudimentary balance sheet equation:
Assets = Liabilities + Equity
Assets represent those things of value that a company owns and has in their possession such as cash, inventory stock, plant, machinery and equipment. Another aspect of a company’s assets are accounts receivable, which represents money owed but not yet paid. This money is expected to be received and can be tangibly measured.
Liabilities are the debts that your company owes to others, obligations that must be meet and paid for under specified terms and conditions. Liabilities comprise of outstanding payments for supplies and inventory stock, loans and credit card debt. Other examples of liabilities include taxes, wages and entitlements payable to your employees.
Owner's equity is the portion of the company’s assets that are owned free and clear. It is the difference between what your company owns as assets and what it owes as liabilities. In other words, if you were to liquidate all your assets and pay off all your liabilities, the leftover amount would be your ‘owner’s equity’.
Equity = Total Assets – Total Liabilities
Businesses are usually valued based on a multiple of its earnings, referred to as the ‘book value’, which considers such intangible assets as intellectual property, patents and goodwill. In real terms, the value of a business can be greater than the value of the owner’s equity, if it were to be sold.
Presenting the Balance
In the asset sections, your accounts are listed as current and non-current assets in the descending order of their liquidity, or how quickly and easily each can be converted to cash.
Current assets are expected to be converted into cash within one fiscal year, while non-current assets are long-term assets that a company expects to hold for longer than one year. For example, current assets are cash (on hand or in the bank), short-term investments, accounts receivable and inventory stock, while non-current assets include land, buildings, machinery and equipment.
Likewise, liabilities are listed in the order of their priority for payment. Current liabilities such as accounts payable, salaries and taxes are listed before long-term loans and mortgages, which represent your non-current liabilities.
A document of two sides, or more specifically, two columns, the balance sheet is so named because the two sides must always ‘balance’ with each side adding up to precisely the same amount.
The double entry system of accounting dictates that every transaction your business makes, involves two or more accounts. For example, if your company borrows money from the bank, your ‘cash’ assets will increase on one side and ‘loans payable’ will also increase on the opposite column under liabilities.
Balance for a Day
Your balance sheet will represent your company's financial position for one day at the end of your business cycle or the last day of your accounting period.
A company’s fiscal year will generally differ from that of the Gregorian calendar year because businesses will typically select a year-end period that corresponds with the natural business year of their company. Usually a time when business activities have reached the lowest point in their annual cycle.
The most important point to remember is that both sides of the balance sheet must add up to the same amount, regardless of when a balance sheet is produced.