Introduction to Balance Sheet
A balance sheet is a financial statement that shows the financial position of a company at a given point in time. It records the assets and liabilities of the business at the end of the accounting period after the preparation of trading and profit and loss accounts. The balance sheet is divided into two parts: assets and liabilities. Assets are what a company owns, such as cash, inventory, property, and equipment. Liabilities are what a company owes, such as loans, accounts payable, and taxes. The difference between assets and liabilities is called equity or net worth. Balance Sheet is used by investors, creditors, and management to evaluate the financial health of a company.
Why is a Balance Sheet important?
- A balance sheet is a vital financial statement that shows a company’s financial condition at a certain moment. It displays a company’s assets, liabilities, and equity.
- Investors, creditors, and managers use the balance sheet to understand the company’s financial well-being. Investors look at it to decide if they want to invest money in the company.
- Creditors use it to decide if they should lend money to the company and Managers use it to figure out how to use resources and handle debts.
- The balance sheet is also used to calculate important financial ratios like debt-to-equity and current ratio.
Balance Sheet Equation
The Balance Sheet Equation, also known as the Accounting Equation, is a fundamental concept in accounting that represents the relationship between a company’s assets, liabilities, and equity. It can be summarized as follows:
Assets = Liabilities + Equity
In simple terms, the equation shows that a company’s resources (assets) are funded by either what the company owes (liabilities) or what the owner has invested (owner’s equity). This equation ensures that a company’s financial records are always balanced.
For example: Let’s say you decide to start a lemonade stand. You invest Rs10,000 of your own money (owner’s equity) and borrow Rs 5,000 from a friend (liability). With this money, you buy a table, some lemons, sugar, and cups (assets) for Rs15,000.
The Balance Sheet Equation in this scenario would be: Rs15,000 (Assets) = Rs 5,000 (Liabilities) + Rs 10,000 (Owner’s Equity)
This shows that the total value of your lemonade stand’s assets (Rs 15,000) is equal to the sum of what you owe (Rs 5,000) and your initial investment (Rs 10,000). The equation always holds true, ensuring that your financial records are in balance.
Components of Balance Sheet
Assets are things that a person or a company owns that have value. They can be things like money, buildings, equipment, and even things like computers or furniture. Assets are important because they show how much value a person or a company has.
For example: Imagine a bakery. The ovens they use, the money they have, the delivery vans, and even the recipes they developed – all of these are assets. These pieces help make the bakery run and they determine the bakery’s total value on paper.
They can be divided into two categories: current assets and long-term assets.
Current Assets: Current assets are those that can be converted into cash within one year. Examples of current assets include cash, accounts receivable, and inventory.
Long-term Assets: Long-term assets are those that cannot be converted into cash within one year. Examples of long-term assets include property, plant, and equipment.
Liabilities are promises a company makes to pay back money or do something in the future. They include loans, unpaid bills, and obligations. They show what the company owes to others.
For example: Think of a store that borrows money from a bank to buy inventory. The money they borrowed is a liability because they have to pay it back. Any bills they haven’t paid yet, like rent or utilities, are also liabilities. These show the company’s financial responsibilities and commitments.
They can also be divided into two categories: current liabilities and long-term liabilities.
Current Liabilities: Current liabilities are those that must be paid within one year. Examples of current liabilities include accounts payable and short-term loans.
Long-term Liabilities: Long-term liabilities are those that do not have to be paid within one year. Examples of long-term liabilities include long-term loans and bonds.
Equity represents the residual interest in the assets of the company after deducting liabilities. It is also known as net assets or shareholders’ equity.
For example: Imagine a software company. If they’ve earned more money from selling their programs than they spent on expenses, that extra money is profit. This profit adds to the company’s equity. Also, if the owner put more money into the company, that increases equity too. Equity is a piece of the company’s value that belongs to the owner or owners.
Equity can be further divided into two categories: Share capital and retained earnings.
Share Capital: Share capital is the amount of money that shareholders have invested in the company.
Retained Earnings: Retained earnings are the profits that the company has earned but has not distributed to shareholders.
Things to be considered while preparing a Balance Sheet
- Determine the reporting date and period: A balance sheet is meant to depict the total assets, liabilities, and shareholders’ equity of a company on a specific date, typically referred to as the reporting date. Often, the reporting date will be the final day of the accounting period.
- Classify assets and liabilities into current and long-term categories: Assets and liabilities should be classified into current and long-term categories. Current assets are those that can be converted into cash within one year, while long-term assets are those that cannot be converted into cash within one year. Current liabilities are those that must be paid within one year, while long-term liabilities are those that do not have to be paid within one year.
- Ensure that assets are listed in order of liquidity: Assets should be listed in order of liquidity, meaning that the most liquid assets should be listed first. This makes it easier to determine how much cash is available to pay off debts.
- Ensure that liabilities are listed in order of maturity: Liabilities should be listed in order of maturity, meaning that the liabilities that are due soonest should be listed first.
- Calculate the total assets and total liabilities + equity: The total assets and total liabilities + equity should be calculated to ensure that the balance sheet balances (i.e., total assets = total liabilities + equity).
- Ensure that the balance sheet balances (i.e., total assets = total liabilities + equity): The balance sheet must balance, meaning that the total assets must equal the total liabilities + equity.
- Calculate important financial ratios such as the debt-to-equity ratio and the current ratio: Financial ratios such as the debt-to-equity ratio and the current ratio can provide valuable insights into a company’s financial health.
Example of Balance Sheet
The image above is an example of balance sheet ABC Supermarket Pvt Ltd. This balance sheet compares the financial position of the company as of Fiscal Year2078/79.
In this example, ABC Supermarket Pvt Ltd total assets is “Two crore thirty five lakhs twenty three thousand seven hundred seventy nine”, Where it also shows that total equity and liabilities also ” Two crore thirty five lakhs twenty three thousand seven hundred seventy nine”. It means that the Balance Sheet is match.
Balance Sheet Analysis
Balance sheet analysis is an important tool for investors, creditors, and other stakeholders to evaluate a company’s financial health. Here are some of the main points to consider when analyzing a balance sheet:
- Liquidity: The liquidity of a company’s assets is an important factor to consider when analyzing a balance sheet. The more liquid the assets, the easier it is for the company to meet its short-term obligations.
- Solvency: Solvency refers to a company’s ability to meet its long-term obligations. A company with a high level of debt relative to its equity may be at risk of defaulting on its long-term obligations.
- Debt-to-equity ratio: The debt-to-equity ratio is a measure of a company’s leverage. A high debt-to-equity ratio indicates that the company is relying heavily on debt to finance its operations.
- Current ratio: The current ratio is a measure of a company’s ability to meet its short-term obligations. A high current ratio indicates that the company has sufficient current assets to cover its current liabilities.
- Return on equity (ROE): ROE is a measure of how much profit a company generates relative to the amount of shareholder equity. A high ROE indicates that the company is generating strong returns for its shareholders.
- Asset turnover ratio: The asset turnover ratio measures how efficiently a company is using its assets to generate revenue. A high asset turnover ratio indicates that the company is generating strong revenue relative to its assets.
Free Balance Sheet Template for Accountants
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How to Learn Balance Sheet from Khata Business Academy
Khata Business Academy offers two online courses that can help you learn and prepare Financial Reports including Balance Sheet, Profit & Loss, Cash Flow and Financial Projections:
- Learn Financial Reports: This course covers the basics of financial statements preparations. You will learn how to prepare Transactional Reports, Taxation Reports, Financial Reports and Projection Reports. Recommended for accountants with 1-3 years of experience.
- Learn NFRS For Accountants: This course covers the concepts, implementation and reporting framework under Nepal Financial Reporting Standard (NFRS) based on IFRS. NFRS is being implemented in Nepal from FY 2080-81 onwards. Recommended for account managers.
Both courses are taught by experienced Chartered Accountants and are designed to help you gain the skills and knowledge you need to succeed in a career in accounting.
If you are interested in learning more about these courses, please visit the course landing pages below: