What Is Balance Sheet? Format And Examples of Balance sheet
A balance sheet reports a company's assets, liabilities and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It is a financial statement that provides an overview of what a company owns and owes, as well as the amount invested by shareholders.
Balance sheet is not an account, it is a statement showing the balance remaining in the books. The balance sheet must be headed as "The balance as at 31st......."
BREAKING DOWN 'BALANCE SHEET'
The balance sheet adheres to the following equation, where assets on one side, and liabilities plus shareholders' equity on the other, balance out:
ASSETS
Within the assets segment, accounts are listed from top to bottom in order of their liquidity, that is, the ease with which they can be converted into cash. They are divided into current assets, those which can be converted to cash in one year or less; and non-current or long-term assets, which cannot.
Here is the general order of accounts within current assets:
- Cash and cash equivalents: the most liquid assets, these can include Treasury bills and short-term certificates of deposit, as well as hard currency
- Marketable securities: equity and debt securities for which there is a liquid market
- Accounts receivable: money which customers owe the company, perhaps including an allowance for doubtful accounts (an example of a contra account), since a certain proportion of customers can be expected not to pay
- Inventory: goods available for sale, valued at the lower of the cost or market price
- Prepaid expenses: representing value that has already been paid for, such as insurance, advertising contracts or rent
ALSO READ: MEANING OF ASSETS: ALL YOU NEED TO KNOW
LONG-TERM ASSETS INCLUDE THE FOLLOWING:
- Long-term investments: securities that will not or cannot be liquidated in the next year
- Fixed assets: these include land, machinery, equipment, buildings and other durable, generally capital-intensive assets
- Intangible assets: these include non-physical, but still valuable, assets such as intellectual property and Goodwill.
- Liquid assets: These are assets that can be easily turned into cash e.g debtors, investment, etc
In general, intangible assets are only listed on the balance sheet if they are acquired, rather than developed in-house; their value may, therefore, be wildly understated—by not including a globally recognized logo, for example—or just as wildly overstated
LIABILITIES
Liabilities are the money that a company owes to outside parties, from bills it has to pay to suppliers to interest on bonds it has issued to creditors to rent, utilities and salaries. Current liabilities are those that are due within one year and are listed in order of their due date. Long-term liabilities are due at any point after one year.
Current liabilities accounts might include:
- Current portion of long-term debt
- Bank indebtedness
- Interest payable
- Rent, tax, utilities
- Wages payable
- Customer prepayments
- Dividends payable and others
Long-term liabilities can include:
- Long-term debt: interest and principal on bonds issued
- Pension fund liability: the money a company is required to pay into its employees' retirement accounts
- Deferred tax liability: taxes that have been accrued but will not be paid for another year; besides timing, this figure reconciles differences between requirements for financial reporting and the way tax is assessed, such as depreciation calculations
Some liabilities are off-balance sheet, meaning that they will not appear on the balance sheet. Operating leases are an example of this kind of liability.
Shareholders' Equity
Shareholders' equity is the money attributable to a business' owners, meaning its shareholders. It is also known as "net assets," since it is equivalent to the total assets of a company minus its liabilities, that is, the debt it owes to non-shareholders.
Retained earnings are the net earnings a company either reinvests in the business or uses to pay off debt; the rest is distributed to shareholders in the form of dividends.
Treasury stock is the stock a company has either repurchased or never issued in the first place. It can be sold at a later date to raise cash or reserved to repel a hostile takeover
Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the "common stock" or "preferred stock" accounts, which are based on par value rather than market price. Shareholders' equity is not directly related to a company's market capitalization: the latter is based on the current price of a stock, while paid-in capital is the sum of the equity that has been purchased at any price.
IMPORTANCE OF BALANCE SHEET
The data displayed on the balance sheet provides a business with a better idea of the financial state of the business in the given time period. Questions about liquidity and efficiency are two of the more common aspects of a business revealed in the balance sheet.
Liquidity: liquidity is generally more thoroughly measured by applying one or more ratios to produce a percentage that can easily be compared against previous, future, and market percentages. The ratios most commonly used are the current ratio and the quick ratio.
Efficiency: efficiency seems fairly straightforward as it involves how well a business is managing its assets including working capital . This provides a better idea of the financial efficiency on a day-to-day basis for the given time period.
The balance sheet can also provide insight into a business's leverage, which can illustrate the amount of risk being taken, as well as the returns, such as returns on investment (ROI).
Limitations of balance sheet
There are many items with great financial value which are important to the users of financial statements in making reliable decisions but are not included in the balance sheet because they cannot be measured objectively. Such items include the skills of an IT company, a sound customer base and high reputation etc.
The current fair value of various assets and liabilities may be important for some decision makers but the balance sheet does not disclose it because assets and liabilities are mostly reported at their historical costs.
The value of some items is reported on the basis of judgments and estimates in the balance sheet. For instance, the depreciation is normally calculated on the basis of estimated life of the assets. Therefore, the book value reported in the balance sheet is also an estimated value. Another example is the accounts receivable that are reported at their estimated net realizable value.
There are many items with great financial value which are important to the users of financial statements in making reliable decisions but are not included in the balance sheet because they cannot be measured objectively. Such items include the skills of an IT company, a sound customer base and high reputation etc.
The current fair value of various assets and liabilities may be important for some decision makers but the balance sheet does not disclose it because assets and liabilities are mostly reported at their historical costs.
The value of some items is reported on the basis of judgments and estimates in the balance sheet. For instance, the depreciation is normally calculated on the basis of estimated life of the assets. Therefore, the book value reported in the balance sheet is also an estimated value. Another example is the accounts receivable that are reported at their estimated net realizable value.
FORMAT OF A BALANCE SHEET
Basically, there are two formats of presenting assets, liabilities and owners’ equity in the balance sheet. They are: account format and report format.
In account format, the balance sheet is divided into left and right sides like a T account. The assets appear on the left hand side while both liabilities and owners’ equity will appear on the right hand side of the balance sheet. If all the details of the balance sheet are listed correctly, the total amount of asset side (i.e., left side) must be equal to the total amount of liabilities and owners’ equity side (i.e., right side).
In report format, the balance sheet elements are presented vertically i.e., assets section is presented at the top and liabilities and owners equity sections will appear below the assets section.
The example given below shows both the formats.
In account format, the balance sheet is divided into left and right sides like a T account. The assets appear on the left hand side while both liabilities and owners’ equity will appear on the right hand side of the balance sheet. If all the details of the balance sheet are listed correctly, the total amount of asset side (i.e., left side) must be equal to the total amount of liabilities and owners’ equity side (i.e., right side).
In report format, the balance sheet elements are presented vertically i.e., assets section is presented at the top and liabilities and owners equity sections will appear below the assets section.
The example given below shows both the formats.
Account format:
Report format:
Balancing a Balance Sheet
When preparing a balance sheet for your business it’s important to note that, your balance sheet must always be balanced, as the name suggests. Just as I stated above, A balance sheet is divided into two sections, one side representing your business’s assets and the other showing its liabilities and shareholders equity.
When added together, the total value of your assets must be equal to the combined value of your liabilities and equity. When this happens, your balance sheet is said to be in balance. This idea is represented by the foundational formula of balance sheets:
Assets = Liabilities + Shareholder Equity
This formula is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders' equity).
For example, if a company takes a loan of $4,000 from a bank, its assets (the cash account) will increase by $4,000. Its liabilities (the loan account) will also increase by $4,000, balancing the two sides of the equation. If the company takes $8,000 from investors, its assets will increase by that amount, same as its shareholders' equity. All revenues the company generates in excess of its expenses will go into the shareholders' equity account. These revenues will be balanced on the assets side, appearing as cash, investments, inventory, or some other asset.
