A balance sheet is an important document to a business that provides a snapshot of what the company owns and what the company owes at any given time. It is especially important to potential creditors or investors if they are to verify whether investing would be a good decision. Essentially, the balance sheet portrays the financial health of a company. But what components can be found on the balance sheet and what exactly do they mean? Read on to find out.
The basic balance sheet
There are three major components of a balance sheet namely the assets, liabilities and equity. These three components relate to each other through the following equation: Assets = Liabilities + Equity. This equation makes sense in so far as anything the company can call their own or that has a positive value can only be equal to the sum of both its retained earnings and what it owes to other parties.
The assets incorporate anything the company has purchased, owns and holds a future monetary value if used or sold. It is important to note that assets also include bills that have been prepaid and are still valid for use such as prepaid electricity, leasing fees, advertising and so on.
Some items listed under assets might include cash, petty cash, accounts receivable, inventory stock, buildings, land and equipment. Another important point about assets is that it does not matter who actually owns the items whether be the bank in the form of a loan or someone else. As long as it is in possession of the company, any item is considered an asset.
Liabilities is anything that the company is liable for be it unpaid bills, mortgage or leasing debt or anything else. They are any financial commitments the company has and must honour at a future date.
The business’s equity is anything it owns after all debts have been paid off. This may be cash or items that are free from repayments. It sounds in some ways like it is the sum value of the company, however if sold, the company is usually worth more (its book value) than the equity value.
The balance sheet itself
The balance sheet itself has two columns. The left contains any assets the company has while the right denotes the liabilities and owner’s equity. As the equation states, the left column always equals the right column or it must always balance, if you will.
When composing the balance sheet, the asset accounts are listed in order of their ability to be liquidated should quick cash be required. Likewise, the liabilities are listed in order of their need to be settled.
What does the balance sheet allude to?
The balance sheet gives investors or anyone for that matter, a snapshot of the financial status of the company at one point in time. If a more generalised picture is required, the cash flow statements are the documents to consult. To gain an understanding of the average financial obligations of the company over time, it is common practice to average two balance sheets, perhaps one at the start and the end of the financial year. This provides a fairly accurate approximation of what assets and liabilities the company had had over the whole year.
Inventory stock and the balance sheet
Since the balance sheet contains information on the assets (including inventory stock) and the liabilities (payments for said inventory stock), it is important to have accurate records of this at any given time. Believe it or not, to do so does not require diving through the warehouse every two weeks and conducting a physical count which undoubtedly would account for discrepancies in numbers and the stock manager’s raised blood pressure. There is an easier way in the form of inventory management software such as Unleashed. This allows tracking and recording of all inventory stock with ease so that things are perpetually updated, accurate and stored in an ordered manner.