What is a Balance Sheet in Accounting
In accounting, the balance sheet is one of the three basic financial statements and is essential to both financial modelling and accounting. The balance sheet shows the total assets of the firm as well as how these assets are funded, whether through debt or equity. It’s also known as a statement of net worth or a statement of financial position.
Balance Sheet Formula
The balance sheet is based on the fundamental accounting equation:
Assets = Liabilities + Equity
What Items Are on a Balance Sheet?
The balance sheet is split into two parts (or sections). The balance sheet’s left side lists all of a company’s assets and the right side describes the company’s liabilities and shareholders’ equity.
Accounts are listed in the assets section from top to bottom in order of liquidity – that is, the ease with which they can be transformed into currency. They are classified as current assets, which can be converted into money in a year or less, or non-current or long-term assets, which cannot.
Cash and cash equivalents: the most liquid assets, which may include Treasury bills, short-term certificates of deposit, and hard currency.
Marketable securities: These are equity and debt securities that have a liquid market.
Accounts receivable: refers to money owed by customers to the firm, and may include an allowance for doubtful accounts since a certain percentage of customers fail to pay.
Inventory: It is commodities that are available for sale and are valued at the lowest of the cost or market price.
Prepaid expenses: denote the value that has already been paid for, such as insurance, advertisement contracts, or leases.
Non-Current or Fixed Assets
Long-term investments: are those that are not or cannot be liquidated within the next year.
Fixed Assets: Land, machinery, facilities, construction, and other long-lasting, capital-intensive assets are examples of fixed assets.
Intangible assets: They are non-physical assets that are also worthwhile, such as intellectual property and goodwill.
Liabilities are the sums of money that a company owes to third parties, ranging from bills owed to manufacturers to interest on bonds issued to creditors to leases, utilities, and employment. Current liabilities are those that are due within a year and are listed in the order in which they are due. Long-term liabilities are due for one year at any time.
Some current liabilities are bank indebtedness, interest payable, wages payable, customer prepayments, dividends payable, earn and unearned premiums and accounts payable.
Long term Liabilities:
Long-term liabilities include long-term borrowing, deferred income taxes, and pension fund liabilities. Some liabilities are called off the balance sheet, which means they will not appear on the balance sheet.
Another vital section of the balance sheet is a shareholder or owner’s equity. Total liabilities plus owners’ equity equal assets. When a company is a sole proprietorship, the owner’s equity is used, and when a company is a corporation, shareholders’ equity is used. It is also referred to as the book value of the company.
Share holder’s equity:
The amount of money produced by a company, the amount of money put into the business by its owners (or shareholders), and any donated capital are all referred to as shareholders equity. Your net assets are your shareholders’ equity. It is computed on your balance sheet using the following formula:
Stakeholders Equity = Total Assets – Total Liabilities
Retained earnings are the net profits that a company either reinvests in the business or uses to pay off debt; the remainder is distributed to shareholders as dividends.
A company’s repurchased stock is known as treasury stock. It can be sold at a later date to raise funds, or it can be held in reserve to fight off a hostile takeover.
Some businesses issue preferred stock, which is listed separately from common stock in the shareholders’ equity section. The “common stock” and “preferred stock” accounts are calculated by multiplying the par value by the number of shares outstanding.
Paid in capital or capital surplus:
The amount spent in excess of the “common stock” or “preferred stock” accounts, which are based on par value rather than the market price, is represented by paid-in capital or capital surplus. Shareholder equity is not directly related to a company’s market capitalization, which is based on the prevailing price of a stock, while paid-in capital is the sum of all equity bought at any price.
Why is the Balance sheet Important?
A balance sheet is an essential financial statement that provides a snapshot of your company’s financial health at a certain point in time. You should also examine your balance sheet alongside your other financial statements to better understand the relationships of various accounts. A balance sheet is useful because it includes the following information about your company:
By comparing your company’s current assets to its current liabilities, you can get a better picture of its liquidity, or how much cash it has on hand. To cover your short-term financial commitments, you should always have a buffer between your existing assets and liabilities, with assets always higher than liabilities.
You can determine how effectively your company uses its assets by comparing its income statement to its balance sheet. For example, you should learn how well your company uses its assets to generate revenue.
FOR DETERMINING LEVERAGE
Your balance sheet can help you understand how much leverage your company has, which can indicate how much financial risk you face. To determine leverage, compare your debts to the equity on your balance sheet.
What is the Most Important Line on the Balance Sheet?
According to many analysts, the top line, or cash, is the most important item on a company’s balance sheet. Accounts receivable, short-term investments, property, plant, and equipment, and significant liability objects are also important.
Forms of the Balance sheet:
Accounting has developed reasonably standard formats for presenting the contents of a Balance Sheet. The account form, report form, and financial stance form are examples of these forms. Each form has a distinct arrangement of contents.
The arrangement of the Balance Sheet data is distinguished by the fact that assets are listed on the left side and liabilities are listed on the right.
The vertical listing of assets, liabilities, and shareholder equity distinguishes this Balance Sheet arrangement. This arrangement is often preferred because it highlights the working capital information.
Balance Sheet Example:
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