A balance sheet is a financial statement that records the assets, liabilities, and equity of a company at a certain point in time and provides a basis for estimating return rates and determining the capital structure. It offers a snapshot of what an entity owns and owes, as well as the sum that shareholders spend.
What is the Formula Used in a Balance Sheet?
The balance sheet complies with the following accounting equation in which assets on the one side, and liabilities plus shareholders' equity on the other, balance out:
*Assets = Liabilities + Shareholders' Equity *
This formula is intuitive: a business must pay for everything it owns (assets) by either borrowing money (taken on liabilities) or taking it via investors (issuance of shareholders' equity).
Assets, shareholders' equity, and liabilities—each of these components are made up of several smaller accounts that give a detailed break down of the particulars of the finances of a company. Such accounts vary greatly from one sector to another, and the same words can have different meanings depending on the nature of the company. Broadly though, investors are likely to come across a few rising components.
Importance of a Balance Sheet
The balance sheet is a snapshot which represents the condition of a firm's finances at a given point in time. This cannot, by itself, offer a sense of the patterns that play out over a longer period of time.
Therefore, it is crucial to equate the balance sheet with those of previous periods. It should also be contrasted with those of other firms in the same industry, as different industries have specific financing approaches.
Several ratios can be extracted from the balance sheet, which helps investors gain a sense of how stable a firm is. It includes the debt-to-equity ratio, the acid-test ratio, and many more.
The income statement and cash flow statement both provide useful information for assessing a company's finances, as make any comments or addenda in an earnings report that may relate back to the balance sheet.