Balance Sheet

The balance sheet, in simple terms, can be defined as a document or a statement that highlights the financial state of a company at any given date. Apart from the assets and liabilities of a company, shareholder’s equity forms an essential part of this financial record. If you plan on pursuing an Accountancy course in order to build a flourishing career in Commerce, understanding the meaning of these terms is necessary.

While assets are the resources that are owned by a particular company, liabilities, on the contrary, are the funding sources of the company. The building or office space owned, the bank balance, the furniture, stationery, etc. are the assets of the company while the bank loans, capital burrowed or due services to customers are the liabilities. At the end of the day, in a month or a financial year, the total assets should be equal to the liabilities as well as the capital invested in the firm. If this happens, then only it would be considered a “balance sheet”. 

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Essential Features

We have already discussed what a balance sheet actually is, how is it maintained and what are the main components. However, to know what is included in the balance sheet or its essential features in detail, go through the following points: 

• A balance sheet is prepared on the last day of an accounting year.

• It is the last step of Final Accounts and is prepared after assessing trading as well as the profit and loss account. This is because the net profit and loss are to be included in the balance sheet through the capital account.

• It consists of all assets as well as liabilities accounts, but no expenses and revenues are shown.

• The two sides of the sheet must always be equal. That is,

Asset = Liability + Capital

This equation should always be followed otherwise the tally in the sheet would be considered faulty.

• The balance sheet describes the nature as well as the value of the asset and the liabilities. One can also know the position of the capital on a particular date through this. 

• It also takes into account the debit and credit balances of the personnel as well as the current charges. The debit balance in the actual account is known as the asset of the firm. Credit balance, on the contrary, is counted in the personal account and is known as the liability of the firm.

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Special Considerations

As previously stated, a balance sheet contains information about a company’s assets, liabilities, and shareholder equity. The assets and liabilities should always be equal to the shareholder equity. As a result, the balance sheet should always balance, thus the name. If they do not balance, some issues may arise, such as incorrect or misplaced data, inventory or exchange rate errors, or miscalculations.

Each category is made up of several smaller accounts that detail a company’s finances. These accounts differ greatly by industry, and the same terms can have varying meanings depending on the nature of the business. However, there are a few common components that investors are likely to encounter.

Why is the Balance Sheet Important?

As discussed, maintaining a balance sheet is a very important component of running a business. It sheds light on the company’s current financial position, the funding resources, and the profits earned. To make things more clear, the importance of the balance sheet has been summarised in the points below:

Financial Analysis

Through a balance sheet, the proprietors can understand the liquidity conditions of the firm i.e, how much they can afford their daily transactions, the cash flow of the company, their working capital funding and trade receivable status.

Helps Investors Make Decisions

Also taught in the Entrepreneurship Development programmes, most investors try to look at the balance sheet of a company before deciding to invest in the same. They also try to follow the trends and assess various other parameters to check the growth of the company.

Helps Banks Understand the Company’s Net Worth

If a company wants to get a loan to finance its future investments and expansion plans, the bank would be looking at its balance sheet to understand whether the company is in a financial position to pay back the loan or not. 

Determination of Risk and Returns

Maintaining a balance sheet can help you easily figure out whether you can meet your short-term obligations easily or not. If your liabilities side is increasing uncontrollably, there is a chance of bankruptcy and the firm running out of money

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Format

Particulars	Schedule	Amount in Rs.
Equity and Liabilities
1. Shareholder’s fund
Share capital Reserves and Surplus		XXXXXX
2. Non-current liabilities
Long term borrowings Deferred tax liabilities Long term provisions		XXX XXX XXX
3. Current Liabilities
Short term borrowings Trade payables Other current liabilities Short term provisions		XXX XXX XXX XXX
Total		XXX
Assets
1. Non-current assets
Fixed assets 1)Tangible assets 2) Intangible assets Non-current investments Long-term loans and advances		XXX XXX XXX XXX
2. Current assets
Current investments Inventories Trade receivables Cash and Cash Equivalents Short-term loans and advances		XXX  XXX XXX XXX XXX
Total		XXX

Limitations of a Balance Sheet

The following are the limitations of the balance sheet:

• The balance sheet alone may not represent the full picture of the financial health of a company.
• A balance sheet is limited due to the restricted scope of timing.
• As a balance sheet can be restrictive to some subjects of professional judgement, it may impact the report materially.

Who Prepares the Balance Sheet?

Depending on the company, various parties may be in charge of preparing the balance sheet. The balance sheet for a small privately held business may be prepared by the owner or a company bookkeeper. They may be prepared internally and then reviewed by an external accountant for mid-sized private firms.

Public companies, on the other hand, must obtain external audits by public accountants and maintain their books to a much higher standard. These companies’ balance sheets and other financial statements must be prepared in accordance with Generally Accepted Accounting Principles (GAAP) and filed on a regular basis with the Securities and Exchange Commission (SEC).

Uses of a Balance Sheet

A balance sheet describes a company’s financial position at a specific point in time. In contrast to an income statement, which reports financial information over time, a balance sheet is used to determine a company’s health on a specific day.

A bank statement is frequently used by parties outside of a company to assess the health of the company. Financial ratios are calculated by banks, lenders, and other institutions based on balance sheet balances to determine how much risk a company carries, how liquid its assets are, and how likely the company will remain solvent.

A company can use its balance sheet to make internal decisions, but the information provided is usually not as useful as that of an income statement. A company may examine its balance sheet to assess risk, ensure that it has enough cash on hand, and decide how to raise additional capital (through debt or equity).

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The Sequence of Accounts in the Balance Sheet

Current assets and liabilities must be recorded separately under Generally Accepted Accounting Principles (GAAP). Similarly, current liabilities must be distinguished from long-term liabilities. Cash, accounts receivable, inventory, and prepaid expenses are examples of current asset accounts, whereas long-term asset accounts include long-term investments, fixed assets, and intangible assets.

Long-term debt, interest payable, salaries, and customer payments are examples of current liability accounts, whereas long-term liabilities include long-term debts, pension fund liability, and bonds payable.

Accounts for assets will be organised in descending order of maturity, while liabilities will be organised in ascending order. Accounts are arranged in decreasing order of priority under shareholder’s equity.

FAQs

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