Financial Accounting: What is a Balance Sheet?

Key Takeaways

  • A balance sheet is a financial statement that summarizes assets, liabilities, and equity for a specific date.

  • The balance sheet reflects every transaction since the inception of the company.

  • The balance sheet is a financial snapshot as of a certain point in time.

What is a balance sheet?

A balance sheet is a financial statement that summarizes assets, liabilities, and equity for a specific date. A balance sheet can be used to evaluate how well an organization is doing financially by looking at its assets, liabilities, and equity.

Assets are what the company owns or controls, including cash or anything else of value. Liabilities are things the company owes to others on which it may have to make future payments such as money borrowed from banks or other lenders; claims against the company brought by customers who bought defective products; unpaid taxes owed because of insufficient funds in taxable accounts. Equity is what remains when assets are subtracted from liabilities.

Yes, but What goes on the balance sheet?

The balance sheet reflects every transaction since the inception of the company. It includes company assets, liabilities, and shareholder or owner equity.

Assets: item of value owned by a business

  • Current assets that can be converted to cash within a year, including cash, marketable securities, accounts receivable, inventory, and prepaid expenses.

  • Long-term assets that cannot be converted to cash within a year, such as property, buildings, machinery, long-term investments, and intangible assets.

Liabilities: money owed to outside parties

  • Current liabilities are those that are due within a year, such as interest payable, wage payable, customer repayments, accounts payable, dividends payable, etc.

  • Long-term liabilities include debt that is due after one year, including deferred tax liability, pension obligations, bonds, loans, etc.

Equity: money generated by the business or put into the business by owners

  • Common stock or paid-in capital is the amount of cash the business owner(s) have given a company in exchange for stock

  • Retained Earnings are the net income or net loss from all years the business has been in operation

  • Net profit includes any net profit or net loss from the current year as shown in the income statement.

Great, now how to read a balance sheet?

A company's balance sheet is also known as the "statement of financial position", showing its assets, liabilities, and owners' equity. The balance sheet is separated into two parts the assets and the liabilities + equity. The formula behind the balance sheet is Assets = Liabilities + Owner's Equity. Essentially, this means that assets are balanced by the company's financial debt along with equity investments by its owners and its retained earnings. The balance sheet is a snapshot of financial position at a certain point in time.

With a deeper understanding of the balance sheet, we can then use different techniques to analyze the information contained in the balance sheet, i.e. financial ratio analysis. Financial ratios lead us into insights where we can understand what these numbers mean in relation to each other and within the context of business operations or industry standards. There are various kinds of ratios depending on the industry, but here are some that could help you better understand the balance sheet.

  • Liquidity Ratios measure a business's ability to pay back its debt obligations as they become due using the company's current assets.

  • Solvency Ratios compare a business's debt obligations with its assets, equity, and net profit in an effort to evaluate the likelihood of staying afloat as it pays back its debt.

  • Profitability Ratios reflect how well a company can generate profits from its business operations relative to its revenue.

  • Debt to Equity Ratios determines how a company has been financing its growth. Higher ratios indicate that a company has been growing due to leveraging debt.

The bottom line!

A company's balance sheet can generate great insights about its financial position. Such insights allow us to make smarter decisions about current expenditures and revenue opportunities going forward.

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