Balance sheet is prepared by accountants to present the balances of company’s asset, liabilities and equity on the last day of the profit period.
Balance Sheet can be defined as a snapshot statement that shows what a company’s assets are, what its liabilities are, and what its equity is at a specific point in time. Balance sheet is also known as statement of financial position.
It shows the fundamental soundness of a company by reflecting its financial position at a report date.
Specific point in time can be the end of the year or quarter or month. If you are preparing financial statements for a month then specific point in time for a balance sheet in this case will be the end of the month. Specific point in time is also known as report date. However, your accountant can prepare balance sheet at any time that you want to know how things stand financially.
As stated at the beginning, balance sheet has three principal component. Components of balance sheet can be shown as follows, its known as “basic accounting equation”;
Assets = liabilities + owner’s equity
By definition, the above equation must always be in balance with assets equalling the sum of liabilities and equity. We can say, assets of the company are financed by liabilities and equity. This means assets can only be bought with funds provided by the owners or borrowed from someone else, for example, bankers or creditors
From this accounting equation, you can find owner’s equity or company’s net worth by subtracting liabilities from assets.
Assets – liabilities = owner’s equity
This means what the company has today (assets) minus how much the company owes today (liability) is equal to what the company worth today.
However, this simple equation will not give complete answer to company’s financial position. To know the type and amount of asset, liability and capital account at the end of the period, company prepare balance sheet with classifications of these major items.
Each part of this accounting equation are discussed below.
Assets – In balance sheet it shows what you own
Assets are anything of value that a company owns. Assets are of two main types and are classified under the headings of either fixed assets or current assets.
Fixed assets are the hardware or physical things owned and used by the company and are not sold to customers. Examples of fixed assets include buildings, plant, machinery, vehicles, computers, furniture and fittings.
Current assets are cash, things that will be converted into cash within a year from the date they are listed on the balance sheet. Example of current assets include stocks, work-in-progress, marketable securities, trade accounts receivable, bank balance, cash, prepaid expenses and assets.
Therefore we can say:
Total assets = Fixed assets + Current assets.
Fixed asset and current assets are further broken down into short-term and long-term assets.
Liabilities – What the company owes to outsiders
Liabilities are what the company owes to outside parties. A company might owe money to employees, vendors, banks and government agencies. Liability on the balance sheet shows how much cash will be needed to settle these debts.
If dues are to be settled within the next year from the date of balance sheet then its known as current liability. Long-term liability needn’t be paid for at least a year.
Liabilities and owner’s equity represent claims against a company’s assets. That’s why the balance sheet balances.
Owner’s equity – Net Worth of the company
Owner’s equity is the stake that shareholders have in the company, which is also known as shareholders equity.
In case of partnership firm and proprietorship business, it’s called partner’s equity or capital and owner’s equity respectively. It shows what the company is worth to its owner.
Shareholders equity is simply the difference between company’s assets and liabilities. This means, if the company sell all of it’s asset at book value and uses the proceeding to pay liabilities, then whatever left out with the company will be given to owners. Owner’s capital is also known as net worth of the company.
Retained earning is last year’s retained earning plus this year’s profit carried forward to balance sheet. It’s part of company’s net worth.