Business, Legal & Accounting Glossary
A statement of the financial position of an entity showing assets, liabilities and ownership interest.
A financial report that summaries a company’s assets (what it owns), liabilities (what it owes) and owner or shareholder equity; at a given time.
The balance sheet is a statement showing the financial position of a business at a certain date – usually the end of the financial year. The idea is to have a single simple document which offers a way of measuring the financial position of the business and to judge its creditworthiness and value as an investment.
The balance sheet will show the balances of the business’s accounts separated into liabilities (capital invested, creditors, reserves for tax bills, provisions for staff pensions, etc.) and assets (land, buildings, machinery, stock, cash, investments, amounts due from debtors).
Balance Sheet is one of the major financial statements, the others being the income statement, statement of changes in equity and statement of cash flows. Unlike the other financial statements, the balance sheet is accurate only at one specific moment in time, usually at the close of an accounting period.
If you are a proprietor of or a partner in a small business (especially a home business) and your business has not grown to a point where you actually need an accountant, you can construct financial statements for your business on your own to find out what your business is really worth.
A balance sheet is a snapshot of the financial position of a company. On the left side are the assets, and on the right side are the liabilities and owners’ equity. Thus the balance sheet represents the fundamental accounting equation: Owners Equity (or Net Worth) = Assets – Liabilities (or Net Assets). The assets are listed in the order they can be converted to cash; the liabilities, in the order they must be liquidated. Thus the balance sheet shows whether the company is liquid, ie, whether it can meet its short-term obligations. The balance sheet also shows the company’s leverage, ie, the ratio between capital supplied by creditors and capital supplied by owners. The balance sheet has several drawbacks, however. Some asset values on the balance sheet are historical and don’t accurately reflect current values. Moreover, not all of the company’s assets (like customer loyalty) and not all of its actual liabilities (like off-balance sheet items) are reflected in the balance sheet. Despite these negatives, a balance sheet is a primary tool for both credit and equity analysts.
On a specific date it lists:
Where the profit and loss account tells you how the company has performed in the previous year, the balance sheet reveals things about its fundamental health, like whether it can pay its debts and how good its cash management is. A ‘strong’ balance sheet is one where liabilities (including borrowings) are considerably outweighed by assets (including cash).
The first thing you have to be careful about is to make sure that you don’t mix up your personal finances.
There are two sides to a balance sheet:
The two sides are inextricably linked through the basic accounting equation:
Assets = Liabilities + Shareholders’ Equity
Another way of stating that equation is:
Shareholders’ Equity = Assets – Liabilities
In other words, the accounting value of a company that is attributable to its shareholders is equal to the total value of its assets less the value of all the liabilities it carries (that is why shareholders’ equity is sometimes referred to as ‘net assets’).
One way to think about this is in business liquidation, if the owners sell all the assets and repay all outstanding liabilities, shareholders’ equity is an accounting estimate of what is left for the owners.
Many investors don’t spend enough time examining the balance sheet, but it’s extremely useful, not least because it enables one to assess the level of a company’s indebtedness. Prudent investors avoid companies that are highly leveraged, as a high debt load can cripple a company and puts equity owners’ value at risk.
Mercedes needed a strong balance sheet.
Draw up a balance sheet and profit and loss account for Google.
Companies need to focus on both sides of the balance sheet: spending and earning, debits and credits.
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This glossary post was last updated: 4th August, 2021 | 24 Views.