If you are a Business Owner or Investor you are likely to come across the Balance Sheet multiple times in your life so it's important that you understand it well.
A Balance Sheet is a Financial Statement which gives the reader a 'snapshot' of the companies financial condition at a given point in time. It lists out what the company owns and what the company owes giving insights into the overall health of the business.
The Balance Sheet is important because it helps users make decisions.
For Example, it helps Business Owners and Managers make better strategic decisions by answering questions such as -
It helps Bankers and Investors make sound investing decisions by answering questions such as
To fully understand a Balance Sheet - you must understand the 3 elements that make up a Balance Sheet.
Assets are the resources that a company owns. These resources are expected to provide future economic value to the business. Assets of a business include cash, accounts receivable, inventory, vehicles, machinery and goodwill amongst many others. To learn more about Assets, check out our post here.
Everybody owes something to someone and a Business is no different. Liabilities show what all the obligations of a company are and all that the company owes. This includes all Financing or borrowing, all money owed to suppliers etc. To dig deeper into Liabilities, check out our post here.
The Equity Elements of the Balance Sheet shows the contribution made by the Business owners into the Business and any past profits retained in the Business To learn more about Equity, check out our post here.
The 3 Elements - Assets, Liabilities and Equity are listed as SEPERATE SECTIONS in a Balance Sheet and come in 2 basic styles.
The Account Format which is a horizontal presentation of the 3 elements.
Long Term Assets
TOTAL LIABILITIES + OWNERS EQUITY
The Report Format which is a vertical presentation of the 3 Elements.
Long - Term Assets
Long Term Liabilities
TOTAL LIABILITIES + SHAREHOLDERS EQUITY
Each of the above 3 Elements relate to one another.
To understand how the 3 Elements fit together - you need to become familiar with what is called "THE ACCOUNTING EQUATION"
The Accounting Equation formula states:
ASSETS = LIABILITIES + OWNERS EQUITY
This formula ties the 3 elements - Assets, Liabilities and Equity together.
But what does this really mean?
It means that ALL Assets purchased in a Business have been purchased in one of two ways which are - By Financing of some sort (Liabilities) or Owner funds (Equity).
That's why Assets = Liabilities + Owners Equity
Pretty simple right!
Once you understand the Accounting Equation, understanding the Balance Sheet of any company is a snap!
Just be aware of the simple concept -
The Assets of a Business are the Elements that produce Revenue for the firm, and the Balance Sheet gives you a big picture view of the Assets AND a big picture view of the Liabilities and Owners Funds (Equity) used to purchase those assets.
Now how's that for Superpower Document!!!
TOTAL CURRENT ASSETS
TOTAL CURRENT LIABILITIES
Plant and Machinery
TOTAL LONG TERM LIABILITIES
TOTAL FIXED ASSETS
TOTAL LIABILITIES + EQUITY
So, what does the Balance Sheet tell you about the Business?
Well, quite a lot!
Let's start with the Assets side
Now, let's understand the Liabilities
Finally, we come to the Equity Section where we see...
As you start reading the Balance Sheet of Larger corporations, you will see that they don't used very large numbers such as 5,000,000,000 or exact matches such as 5,642,749,888.45. Companies prefer to round off numbers to make the Balance Sheet easier to read for users. Details of the rounding off of these numbers is usually mentioned on top of the Balance Sheet.
Every set of Financial Statements is accompanied by a "Notes to Financial Statements" section.
The Notes show more detail on every aspect defined above.
Ironically, the notes of an annual report often take up more room and contain much more detail then the Financial Statements themselves.
To summarize, the Balance Sheet is a 'snapshot' of a company in time.
The Balance Sheet consists of 3 Elements - The Assets, Liabilities and Owners Equity.
The Foundation of the Balance Sheet is the Accounting Equation which is Assets = Liabilities + Owners Equity
The Balance Sheet comes in 3 formats - The Account Format, the Report Format and the Working Capital Format.
The 3 Main Financial Statements are The Balance Sheet, The Income Statement and The Cash Flow Statement.
If you are new to accounting the next thing I would read about would be the Income Statement or the Cash Flow Statement.
If you want to learn accounting with a dash of humor and fun, check out our video course.