Understanding Balance Sheets: Examples, Components, Key Features, and Importance

Last Updated : July 20, 2023, 2:04 p.m.

Have you ever wondered how to evaluate a company’s financial well-being? Look no further than the balance sheet.

The balance sheet effectively presents a snapshot of a company’s financial status. It contains what a company has, what it owes, and its overall net value. Consider it as a guide that directs investors, business owners, and curious individuals through financial complexes. In this article, we will explain the balance sheet format, its component, and the importance of balance sheets.

What is Balance Sheet?

The balance sheet informs us about the worth of a business at a certain point in time. It displays the company’s possessions (assets) and debts (liabilities) to external parties. The balance sheet is among a business’s three primary financial reports, alongside the income statement and statement of cash flows. We can determine a company’s finance source and expenditure patterns by examining the balance sheet format.

Example of Balance Sheet

Here is an example of the balance sheet format:

Assets:

• Cash: ₹7,500,000
• Accounts Receivable: ₹3,875,000
• Inventory: ₹15,500,000
• Property, Plant, and Equipment: ₹37,500,000
• Investments: ₹3,875,000
• Total Assets: ₹68,250,000

Liabilities:

• Accounts Payable: ₹5,812,500
• Short-term Loans: ₹3,875,000
• Long-term Loans: ₹15,500,000
• Total Liabilities: ₹25,187,500

Equity:

• Share Capital: ₹22,875,000
• Retained Earnings: ₹21,156,250
• Total Equity: ₹44,031,250

Total Liabilities and Equity: ₹68,250,000

Components of Balance Sheet

Understanding the components of the balance sheet is essential to understand the balance sheet format. There are three main components of a balance sheet. They are:

Liabilities

This section of the balance sheet shows the funds a company owes to others. It includes regular expenses, expenses on loans, other debts, etc. Now, liabilities can be further categorised into two groups:

Current Liabilities

The notes that are payable within a year, current maturities of long-term debt, and accounts payable fall under current liabilities.

Non-current Liabilities

Non-current liabilities are debts that a company should fulfil over a longer period. Some examples of these debts include taxes that are postponed until a later time, long-term loans that need to be repaid, and long-term debts and notes that the company is accountable for in the future.

Assets

The assets section of a balance sheet contains valuable items you can convert into cash. These items will be listed in order of liquidity, meaning how easily they can be converted to cash. There are two kinds of assets. Let’s discuss them.

Current Assets

The assets easily converted into cash within a year or less are known as current assets. The subdivisions of current assets are:

• Prepaid expenses
• Inventory
• Accounts receivable
• Marketable securities
• Cash and cash equivalents

Long-Term Assets

The assets that can be converted into cash within a year are known as long-term assets. The subdivisions of long-term assets are:

• Fixed assets
• Intangible Assets
• Long-Term Securities

Shareholder’s Equity

Shareholder’s Equity is the sum stockholders have allocated in a company. It comprises the following:

Retained Earnings/Accumulated Profits

Retained earnings are when a company reinvests earnings into its operations rather than distributing them to shareholders as dividends.

Share Capital/Equity Capital

It represents the capital a company acquires for the objective of conducting business.

Key Features of Balance Sheets

The following are the features of the balance sheet format.

Provides a Snapshot of the Business’s Financial Position

A balance sheet format comprises all of a business’s debts and assets. It displays their worth and characteristics, allowing you to determine the status of the company’s capital on a specific date. However, it does not indicate any income or expenses.

Adherence to the Balance Equation

Balance sheets adhere to the equation “Asset= Debt+ Capital”, and both sides are always equal.

It considers the positive and negative balances of a company’s current and personal accounts. The positive balance falls under the personal account and is referred to as the business’s debts. In contrast, the negative balance falls under the real account and is recognised as the business’s assets.

Prepared at the End of the Accounting Year

The company’s accountants typically prepare the balance sheet on the final day of an accounting year. It is because it is the final step of the financial accounts and requires an evaluation of the company’s trading and profit and loss statement for its preparation.

Importance of Balance Sheets

Here are a few of the importance of balance sheets you must know.

Risk Assessment

First, balance sheets help to determine risk. It lists all the assets of the company and all of its liabilities. A company can determine whether it has borrowed too much money, its assets are not easily convertible to cash or has enough liquid assets to meet current demands.

Securing Captial

Companies use balance sheets to obtain capital. A company typically needs to provide a balance sheet to a lender to obtain a business loan and also to private investors when seeking private equity funding. In both cases, the external party wants to evaluate a company’s financial condition, the business’s creditworthiness, and whether the company will be able to repay its short-term debts.

Financial Analysis

Balance sheets provide financial ratios to understand the business’s financial standing. They can be used to assess a company’s liquidity, profitability, solvency, and turnover using financial ratios. The financial ratios sometimes require data extracted from the balance sheet. When analysed over time or compared to competing companies, businesses can better understand ways to enhance their financial condition.

Conclusion

In conclusion, if you are running a business, knowing what is balance sheet is essential to understand your financial business’s financial position. You should know the balance sheet format and understand the terms mentioned in this article to manage your finances and boost your business.

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