A balance sheet shows what assets your business controls and who owns them. A balance sheet is a snapshot of a business’s financial health at a single point in time and lets you know precisely what things of value a business controls, also known as assets. Assets represent items of value that a business owns and has in its possession, or something that can be received and measured objectively. However, when some else owns those assets, they are termed liabilities as these are items which the business owes to others, such as creditors, suppliers, tax, employee wages and so on. They are necessary obligations that must be paid to others. Another facet of the balance sheet is equity, which represents retained earnings and funds contributed by shareholders for example.
The balance sheet has its name because the two sides of the balance sheet need to always add up to the same amount. The balance sheet is separated with assets on one side and liabilities and equity on the other. In other words, the relationship of these items is expressed in the fundamental balance sheet equation:
Assets = Liabilities + Equity
So, what exactly is an asset? An asset is anything of value that your business directly controls. Here are common examples of assets to a business: cash, office equipment, vehicles, inventory and the likes. Accounts receivable are also assets, this number represents money that is owed to you by customers or clients who have not yet paid you.
The thing about assets is the financial ownership does not necessarily matter. The rule of thumb for assets is, if something is in possession of a company, it is considered an asset.
Let’s take for example the question of ‘did you buy a new computer for work?’ This would fall under the category of being an asset. Another example of an asset would be if you bought a scooter for business deliveries. The same is true for if you bought a printing machine for your business, again an asset.
Liabilities are essentially debts you owe to other people or businesses. Some examples of common liabilities are credit card balances that are due, an outstanding payment owed to vendor or a long-term small business loan. The same holds true for if your business needs to pay debts in the future or has any future financial obligations, these debts are also listed in the liabilities section of the balance sheet equation.
Also known as owner’s equity or shareholders equity, it is the difference between what your company owns as assets and owes as liabilities. In other words, it is the portion of the business assets that you own free and clear. It is however important to note and that equity is not necessarily how much the business is worth if it were to be sold. This is because businesses are usually valued based on a multiple of its earnings.
It is important to note that under the asset sections aforementioned, the way accounts are listed in the balance sheet is by descending order of their liquidity, this means how quickly and easily the asset can be converted into cash. Likewise, liabilities are listed in the order of their priority for payment.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. When not writing about inventory management, you can find her eating her way through Auckland.