Balance sheet is also referred to as the statement of financial position, it is one of the five main components of financial statements alongside the income statement, cash flow statement, statement of changes in Equity and notes to the accounts. It shows a company’s assets, liabilities and owner’s equity at the end of the fiscal year, for example at December 31 of a given year. It is a financial statement which summarizes of what a company owns as well as what it owes along with the investment made by the shareholders. It is based on the accounting equation and the principle of duality that assets will be equal to the sum of liabilities and shareholders’ equity every time. This is because these assets are covered the owner’s equity and third-party investment in the business.
The balance sheet is a statement which represents the condition of a company’s finances at a given moment in time. In order to get a real sense of the trends the balance sheet of the current period should be compared with the balance sheets of previous periods. It should also be compared with balance sheets of businesses operating in the same industry.
How a Balance Sheet is Structured?
Balance sheets, like all other components of financial statements, will have minor differences among different business sectors and industries. However, there are several line items that are commonly found in balance sheets of companies belonging to different industries and business sectors. We will briefly go through the commonly found line items on a balance sheet under Non-Current Assets Current Assets, Equity, Non-Current Liabilities and Current Liabilities.
Property, Plant and Equipment (PP&E): Property, Plant, and Equipment (PP&E) represent an entity’s tangible operating fixed assets. The balance of PP&E on an entity’s balance sheet is net of accumulated depreciation. Most companies classify their PP&E as different types of assets, such as Building, Land, computer equipment, furniture and fixtures, etc. Apart from land all other PP&E are depreciable.
Intangibles: This line item represents all of an entity’s intangible assets. Examples of intangible assets include goodwill, brand, licenses, patents, etc.
Accounts Receivable: This line item represents an entity’s overdue invoices, net of any allowances for doubtful debts. As businesses receive payments from customers against outstanding invoices, the balance of this account decreases while the balance of cash or bank increases by the same amount.
Inventory: Inventory on a balance sheet represents the amount that an entity has invested in raw materials, work-in-progress goods, and finished goods. An entity uses this account head when calculating its cost of goods sold for a given period.
Share Capital: This line item on a balance sheet represents the funds that have been invested in the company by the owners/ shareholders. When an entity is formed, shareholders of the entity are required to put in cash in the company in the form of share capital. For example, an investor forms a company and invests $1M in it in the form of share capital, and thus increasing the cash and share capital by $1M.
Long-Term Debt: This represents an entity’s total long-term debt (excluding the current portion of the same long-term debt). This account is derived from the debt schedule, which outlines all of an entity’s outstanding debt, the principal repayment and the interest expense for every period.
Bonds Payable: Bonds payable on an entity’s balance sheet represents the amortized amount of any bond(s) issued which the entity has issued.
Accounts Payable: This represents the amount a company owes to its vendors against items purchased or services rendered on credit. As the company make payments to its vendors, the balance of this account and the cash account decreases by the same amount.
Current Debt: This includes obligations (other than accounts payable) that are due within a one operating cycle for the company or one year’s time (whichever is longest). This can also include current portion of long-term liabilities as well. However, the current portion of non-current liabilities can be presented separately on an entity’s balance sheet as well.
Importance and Use of Balance Sheet
The balance sheet is an integral component of financial statements for many reasons. It can be looked separately as well as in conjunction with other components of financial statements such as statement of profit or loss and the statement of cash flows to get a clear picture about an entity’s financial performance and health.
This statement is a great tool for analyzing an entity’s financial standing at a given date. Financial analysts use balance sheets for calculating a variety of financial ratios that help them in determining as to how well an entity is performing as well as how solvent or liquid a company is. It is an integral element when it comes to preparing an entity’s cash flow statement. In simple words, it’s a financial statement that is very important if you’re interested in knowing the financial position/ standing of a company.