Balance Sheet - Importance, Examples, Components & Features

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.

What is a Balance Sheet?

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.  

Components of a balance sheet 

There are three main components of a balance sheet. They are:

Liabilities

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:

• Current liabilities

Under current liabilities fall notes payable due within a year, current maturities of long-term, debt and accounts payable. 

• Non-current liabilities

Non-current liabilities include deferred tax liabilities, bonds payable, long-term debt and notes payable in the long term. 

Assets

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:

• Current assets

The assets that can be converted easily into cash within a year or less are called current assets. They have the following divisions:

• Long-term assets

Those assets that cannot be converted into cash within a year are called long-term assets. You can further subdivide them into the following:

Shareholders’ equity

Shareholder’s equity is the amount of money stockholders have invested in a company. It includes the following:

• Retained earnings

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.  

• Share capital

This is the amount of capital that a company receives for the purpose of business. 
 

What are the features of a balance sheet?

The features of a balance sheet are as follows:

• A balance sheet consists of all the liabilities and assets of a company. It shows their value and nature enabling you to know the position of the capital on a specific date. However, it does not show any revenues or expenses. 
• Balance sheets follow the equation “Asset = Liability + Capital”, and both of its sides are always equal. 
• It takes into account the credit as well as debit balances of a company’s current and personal accounts. The credit balance comes under the personal account and is called the liabilities of a business. In comparison, the debit balance comes under the real account and is known as the assets of a business.   
• A company’s accountants generally prepare the balance sheet on the last day of an accounting year. This is so as it is the ultimate step of final accounts and needs an assessment of the company’s trading as well as profit and loss account for its preparation. 

What is the importance of a balance sheet?
 

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:

• Assist banks in evaluating a firm’s net worth

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. 

• Helps investors take decisions 

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. 

• Serves as a determiner for risk and returns

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. 

• Enables financial analysis

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. 
 

Balance sheet example
 

Here is a balance sheet format with examples for better understanding:

How to prepare a balance sheet?

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:

• Cash
• Accounts receivable
• Common stock
• Retained earnings
• Inventory
• Fixed assets
• Accounts payable
• Debt
• Accrued liabilities
• Other liabilities
• Other assets 

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. 

Sample format of an accounting balance sheet

This is a sample of a vertical balance sheet format that is generally used by businesses:

                                                          Company Name                                               

Balance sheet as on XX/XX/XXXX

What is the difference between trial balance and balance sheet?

The difference between a trial balance and a balance sheet are as follows:

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.   

Frequently Asked Questions

What is owner’s equity?

Owner’s equity is a part of the three main sections that constitute a sole proprietorship’s balance sheet. 

Does a security deposit fall under current assets?

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. 

What is the meaning of accumulated depreciation?

Accumulated depreciation is the life-to-date depreciation that reduces the book value of an asset. 

What is the meaning of prepaid insurance?

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. 

What are the net assets of a company?

Net assets are the difference between the total assets and total earnings of a company. 
 

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• Unabsorbed Depreciation
• Indian AS 101 – First time adoption of Indian Accounting standards
• Depreciation under Income Tax Act