What does Balance Sheet Mean?
Balance sheet is a financial statement that defines the financial positioning of the company over a period of time, generally a year. This is a statement where the company shares its assets, liabilities and equity of its shareholders. This helps in ascertaining the financial standing of the company. In a nutshell, it gives a glimpse about how much does the company owns and owes to its investors and shareholders.
Balance Sheet is prepared along with other accounting statements such as income and expenditure account, cash flow analysis.
Furthermore, balance sheet simply means the assets and liabilities should be equated or balance out.
How to derive at Balance Sheet?
The simple formula that is used by accountants to derive at balance sheet is to take three main points into consideration.
- Assets- moveable and non-moveable assets owned by a company, such as liquid cash (moveable or transferable), furniture ( non-moveable )
- Liabilities- Debts and payables, such as loan taken as an investment, salaries payable to employees.
- Equity or Capital- Amount invested by shareholders.
Why is Balance Sheet Important for a Company?
Balance sheet is considered as the mother among all other financial statements. It reveals a gamut of information that is needed to ascertain the company’s performance in the respective year.
- The investors and shareholders always look for a balance sheet to know how the company has been performing over a period of time. It helps in revealing return on investment.
- When a company or an organization seeks loan from the banks and financiers, they ask for the balance sheet to study the performance. This helps them in giving loans to healthy organizations not sick units.
- The organization can compare the balance sheet of the last couple of years and ascertain the growth and gaps. This will help to fill the gaps with corrective measures.
- It also allows us to know if there are any possibilities of expansion in the business. If so, what are the expenses that might be need to be taken care of.
What are not covered in Balance Sheet?
Although, balance sheet suggests the financial position of an organization, there are some limitations to it.
- The cost of assets is derived back dated, which means the valuation happens on historical cost. Latest changes in the cost are not considered. Back dated costs are do not really provide any useful insights in the present date.
- It only records the items that can be valued in terms of money. Intangible assets are not recorded in the balance sheet. Skilled employees are also an asset to the company, however balance sheet does not consider them as asset, instead a liability.
- The valuation rules vary for different types of assets.
- Balance Sheet shows some fictitious assets that do not actually add any value to the company. They just inflate the assets without any market value.
- If the reader or interpreter is not aware of the inflationary trends, they may get misled.
Balance Sheet Format
The balance sheet is divided into two parts, left and right.
Left side states Assets and right side states Liabilities.
In the assets section, all the assets are grouped into current assets and non- current assets.
Current assets are those that can be easily quantified in money, such as cash, receivable cash, inventories, and investments.
Non- current assets are long term assets that provide benefits over a longer period of time, more than a year. These assets are known as plant and machinery, land and buildings, equipment, etc. In a balance sheet, current assets come first and long term assets are listed later.
Liabilities are payables to others, such as staff, debtors, etc. These are grouped as current liabilities and long term liabilities. The current liabilities are payables that need to be cleared or paid in a year’s time. These liabilities are usually paid through sale of goods and services or by using the assets of the organizations. Long term liabilities are those which can be cleared off even after a year, usually a long term loan.
When a balance sheet is prepared, the accountant first focuses on liabilities.