Balance Sheet: What it is & how it works?

Balance Sheet


Introduction to Balance Sheet

Balance sheet depicts company’s financial position on a particular date. It is one of the most important financial statements and it is very useful for accountants, bankers, creditors, investors, management, suppliers, customers, competitors, govt. agencies, labour unions etc. It is also called as “statement of financial position”. With the help of balance sheet, you can easily know what company owes to other parties as well as what other parties owes to company on a particular date. Balance sheet even helps bankers in deciding whether company qualifies for a loan or not. With the help of Balance sheet, you can easily understand the financial position of the company.

Balance Sheet

What are Assets?

Assets are the valuable things owned by the business. They are the resources acquired through transactions & having a future economic value. There is a long list of assets which are shown on the asset side of the balance sheet. Some of them are given below –

  1. Cash

  2. Land

  3. Building

  4. Machinery

  5. Goodwill

  6. Inventory

  7. Petty cash

  8. Accounts receivable

  9. Supplies

  10. Temporary investments

It also includes the costs paid in advance such as prepaid insurance, prepaid advertising, prepaid rent & prepaid legal fees etc.

Assets

Normally, assets accounts have debit balances but some asset accounts also have credit balances such as contra assets. Contra assets are asset accounts with credit balances. Some of the contra asset accounts include –

  1. Allowance for doubtful accounts

  2. Accumulated depreciation - Building

  3. Accumulated depreciation – Equipment

  4. Accumulated depreciation – Land improvement

  5. Account depletion

What is Liability?

Liability is an amount that company owes to other parties such as suppliers, banks, creditors etc. In other words, it is an amount borrowed by a company to support its business activities. There is a long list of liabilities which are shown on the liabilities side of a balance sheet. Some of them are given below –

  1. Accounts payable

  2. Salaries payable

  3. Wages payable

  4. Notes payable

  5. Interest payable

  6. Income tax payable

  7. Unearned revenue

  8. Bonds payable

  9. Customer deposits

  10. Other accrued expenses payable

Liability

Normally, liability accounts have credit balances. Contra liabilities are liability accounts with debit balances. Some of the contra liability accounts include –

  1. Discount on bonds payable

  2. Discount on Notes payable

  3. Bond issue costs

  4. Debt issue costs

What is Owner’s Equity

Owner’s equity means assets minus liabilities. In other words, Owner’s equity represents the business owner investment minus the owner’s withdrawal from the business. In the case of Sole-proprietorship, word “Owner’s equity” needs to be used on the right side of the balance sheet whereas word “Stockholder’s equity” needs to be used on the right side of the balance sheet in the case of a corporation. Some of the examples of stockholder’s equity are given below –

  1. Common stock

  2. Preferred stock

  3. Retained earnings

  4. Paid in capital from treasury stock

  5. Paid in capital in excess of par value

  6. Accumulated other comprehensive income etc.

Owner’s Equity

Normally both owner’s as well as stockholder’s equity have credit balances but some owner equity accounts also have debit balances such as contra owner’s equity accounts. Contra owner’s equity accounts are owner’s equity accounts with debit balances.

Classification of Assets on the Balance Sheet

Accountants normally prepare classified balance sheets. Classifying means dividing the balance sheet into different groups, categories etc. The classification of assets on the balance sheet is as follows –

  1. Current asset

  2. Property, plant & equipment

  3. Investments

  4. Intangible assets

  5. Other assets

Company’s Balance Sheet On 31st December 2018
Assets Liabilities & owner’s equity

Current assets
Investments
Property, plant & equipment
Intangible assets
Other assets
Total assets

Current Liabilities
Long-term liabilities
Total liabilities

Owner’s equity
Total liabilities & Owner’s equity

How the Balance Sheet Works?

Balance sheet is divided into two sides – Assets & the other side is liability & owner’s equity. Balance sheet has two sides and both sides must be equal or should have the same balance. In case, if both the sides of balance sheet having different balances, it means some error has taken place in the calculations or any entry is missing or wrongly recorded in the books of accounts.

For example – If Rahul’s company took £8000 loan from the bank. In this case, the assets will increase by £8000 and the liability will also increase by £8000 which results in balancing of accounts.

Assets = Liability + Owner’s equity

The balance sheet gives you a snapshot of company accounts at a given point of time. Balance sheet is a very useful document for investors too as investors look into the balance sheet to know the financial performance of the company before taking the investment decision. It contains three sections –

Assets

Assets are the valuable things owned by the business. Assets side of balance sheet includes cash, inventory, equipment, accounts receivable etc. Assets which are quickly converted into cash are known as current assets.

Liabilities

Liability is an amount that company owes. For ex – Accounts payable, Interest payable, Income tax payable, Salaries payable etc.

Owner’s Equity

Owner’s equity means assets minus liabilities. For ex – Common stock, Preferred stock, Retained earnings etc

Why Balance Sheet is Important?

Balance sheet is very important document because of the following reasons –

  1. It shows the financial performance of the company on a particular date.

  2. It gives you better idea to effectively manage your business in future.

  3. It also guides you and provides you information that how well a business is managing its assets.

  4. It also helps in measuring the liquidity of the business by calculating current ratio & quick ratio.

  5. It is a documented proof showing that your business is running in profits and your financial strength is good.

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