A balance sheet is one of the three crucial financial statements that help in the evaluation of a business. It gives a clear-cut view of a company’s financial state on a given date.
If you run your own company or plan on becoming an accountant, having in-depth knowledge of what is a balance sheet, its components and the way to prepare one is crucial. Let’s dive deeper into this matter.
A company’s balance sheet is a financial record of its liabilities, assets and shareholder’s equity at a specific date. It helps evaluate a business’s capital structure and also calculates the rate of returns for its investors.
Moreover, you can pair a balance sheet with other financial statements to calculate financial ratios and conduct fundamental analysis.
There are three main components of a balance sheet. They are:
This section of the balance sheet shows the money that a company owes to others, like loan expenses, recurring expenses, other forms of debt, etc. Now, liabilities can be further subdivided into two categories:
Under current liabilities fall notes payable due within a year, current maturities of long-term, debt and accounts payable.
Non-current liabilities include deferred tax liabilities, bonds payable, long-term debt and notes payable in the long term.
In the assets section of the balance sheet, you will find items of value that can be converted into cash. These items will be listed in order of liquidity, that is, how easily they can be converted to cash.
Assets can be further subdivided into the following:
The assets that can be converted easily into cash within a year or less are called current assets. They have the following divisions:
|Prepaid expenses||Items of value for which the company has already made a payment, like business insurance, office rent, etc.|
|Inventory||Raw materials, finished products, etc.|
|Accounts receivable||Money that a company’s clients owe for services rendered that is payable in the short term.|
|Marketable securities||Investments that a business can sell off within a year.|
|Cash and cash equivalents||Money saved in a firm’s checking and savings accounts, currency and checks.|
Those assets that cannot be converted into cash within a year are called long-term assets. You can further subdivide them into the following:
|Fixed assets||Machinery, buildings, property, etc.|
|Intangible assets||Patents, copyrights, franchise agreements and more.|
|Long-term securities||Investments that a company cannot sell within a year.|
Shareholder’s equity is the amount of money stockholders have invested in a company. It includes the following:
It is the amount of a company’s gains that are reinvested into its business instead of returning to the shareholders in the form of dividends.
This is the amount of capital that a company receives for the purpose of business.
The features of a balance sheet are as follows:
A balance sheet is an essential component that assists in the smooth running of a business. Here are some of the reasons that explain the importance of a company’s balance sheet:
When a business wants to expand its operations and make future investments, it seeks loans from banks. Under such circumstances, the banks will look at the firm’s balance sheet to evaluate whether or not it has the financial position to pay back the loan amount.
While choosing a firm for the purpose of investment, a majority of investors look at the company’s balance sheet to determine its financial position. Moreover, they combine it with various other factors to assess the firm’s future growth potential.
If you are a business owner, maintaining a balance sheet will enable you to determine the ease at which you can meet your short-term obligations. Furthermore, you can also put a check on the liabilities of your business if they are rapidly growing and avoid the chances of bankruptcy.
Having a proper balance sheet will let you get a clear idea of the liquidity conditions of your company. Thus, you can view the cash flow of your firm, working capital funding, trade receivable status and also how much daily transactions your business can afford.
Here is a balance sheet format with examples for better understanding:
|Current liabilities||–||Current assets||–|
|Accounts payable||Rs.3,50,000||Petty cash||Rs.1000|
|Interest payable||Rs.29,000||Prepaid insurance||Rs.15,000|
|Unearned revenue||Rs.15,000||Accounts receivable||Rs.4,00,000|
|Unearned revenue||Rs.15,000||Temporary investment||Rs.1,00,000|
|Total current liabilities||Rs.5,90,000||Total current assets||Rs.8,84,000|
|Bonds payable||Rs.40,00,000||Property plant and equipment||–|
|Notes payable||Rs.1,54,000||Accumulated depreciation||Rs.5,00,000|
|Total long-term liabilities||Rs.41,54,000||Equipment||Rs.20,00,000|
|Total liabilities||Rs. 47,44,000||Land||Rs.55,000|
|Owner’s Equity||–||Property, plant and equipment – Net||Rs.34,20,000|
|Common stock||Rs.10,00,000||Intangible assets||–|
|Retained earnings||Rs.25,00,000||Trade names||Rs.20,00,000|
|Less: Treasury stock||Rs.5,00,000||Goodwill||Rs.10,50,000|
|Total owner’s equity||Rs.30,00,000||Total intangible assets||Rs.30,50,000|
|Total liabilities||Rs. 77,44,000||Total assets||Rs.77,44,000|
You can follow the steps given below in order to prepare a balance sheet:
Step 1 – Make a trial balance
A trial balance is a regular report that you can find in any accounting software. If the programme has a manual mode of entry, you can make a trial balance by transferring ending balance of every general ledger account into a spreadsheet.
Step 2 – Arrange it properly
In order to make your balance sheet similar to a relevant accounting structure, it is crucial that you properly arrange the initial trial balance. Moreover, if you adjust the trial balance using adjusting entries, please ensure to record all entries completely. This will help auditors understand the reason behind each entry.
Step 3 – Remove all revenue and expense accounts
The trial balance in your balance sheet contains liabilities, assets, equity, expenses, revenue, losses and gains. However, in order to calculate it, you have to delete everything apart from the liabilities, assets and equity.
Although, you will need these deleted accounts for making an income statement.
Step 4 – Make a calculation of the remaining accounts
Now, you must add up all the trial balance accounts. They will include the following:
Step 5 – Validate your balance sheet
In order to validate your balance sheet, the sum total of all assets in the sheet must match the equity accounts of stockholders’ and liabilities.
Step 6 – Present it in the required format
The final step in preparing a balance sheet is to present all this data in the required balance sheet format.
This is a sample of a vertical balance sheet format that is generally used by businesses:
Balance sheet as on XX/XX/XXXX
|Particulars||Note Number||Figures recorded at the end of the current reporting period||Figures recorded at the end of the previous reporting period|
|Equity And Liabilities|
|Reserves And Surplus||Rs.X||Rs.X|
|* Funds Received Against Share Warrants||Rs.X||Rs.X|
|* Share Application Money Pending Allotment|
|* Other Long-Term Tax Liabilities||Rs.X||Rs.X|
|* Net Deferred Tax Liabilities||Rs.X||Rs.X|
|Other Current Liabilities||Rs.X||Rs.X|
|Cash And Cash Equivalents||Rs.X||Rs.X|
|Short-Term Loans And Advances||Rs.X||Rs.X|
|Other Current Assets||Rs.X||Rs.X|
|Intangible Assets Under Development||Rs.X||Rs.X|
|Other Non-Current Assets||Rs.X||Rs.X|
|Net Deferred Tax Assets||Rs.X||Rs.X|
|Long-Term Loans And Advances||Rs.X||Rs.X|
The difference between a trial balance and a balance sheet are as follows:
|Trial Balance||Balance Sheet|
|Trial balance is not a financial statement and does not form a part of a company’s final account||The balance sheet is a financial statement that is an important component of a company’s final account|
|It is made for use within the company||It is made for the company’s external affairs|
|All its accounts are divided into debit and credit balances||All its accounts are divided into equity, liabilities and assets|
|It records the closing balances of all the general ledgers of accounts||It records a company’s equity, liabilities and assets|
|Its purpose is to verify that the total debits and credits of all the ledgers are in balance||Its purpose is to determine whether the business’s assets are equal to the sum of its liabilities and equity|
|For trial balances, there is no specific arrangement rule||For balance sheets, there is a specific arrangement format|
|Auditor’s signature is not mandatory||Auditor’s signature is mandatory|
|Recorded at the end of every year, half-year and quarter||Recorded at the end of every financial year|
Having a properly maintained balance sheet is an excellent way to understand the financial standing of your business. It also helps in attracting prospective investors who may be willing to invest in your company. Furthermore, it helps determine your firm’s financial strengths, pinpoint issues and also measure your business’s progress over a period of time.
Owner’s equity is a part of the three main sections that constitute a sole proprietorship’s balance sheet.
No, a security deposit does not fall under current assets. It is so because if tenants plan on staying for more than a year, they have to report the security deposit as a long-term asset. Thus, it is a non-current asset that falls under “Other Assets” in a balance sheet.
Accumulated depreciation is the life-to-date depreciation that reduces the book value of an asset.
The part of the insurance premium that is paid by a company in advance and hasn’t expired according to the date in the balance sheet.
Net assets are the difference between the total assets and total earnings of a company.