A Balance Sheet, more commonly referred to as the Statement of Financial Position these days, is arguably one of the most commonly talked about financial statements (along with the P/L). To the uninitiated though, the balance sheet might be ‘just another report where something balances with something, and if my accountant says they all balance, then everything is ok’.
Or more accurately, it could be a snapshot of the financial position of your company, at a point in time.
The balance sheet hinges on one fundamental accounting principle – that of the accounting equation: Assets = Liabilities + Shareholders’ Equity. In other words, your company’s assets must balance with the total of the Liabilities and Shareholders’ Equity.
Now you may be wondering what, in accounting terms, these 3 concepts refer to:
These typically refer to resources of the company which have future economic value, such as: Accounts Receivables, Property, plant & equipment, and good old cash in and of itself, among others.
These refer to the company’s financial obligations that are incurred during the course of business. Examples include: Accounts Payable, Deferred Revenue etc.
Equity in accounting terms refers to the owners’ interest in the company – typically, what is left after you have subtracted the company’s liabilities from its assets. It usually consists of a few key items, such as Paid-Up Capital, Retained Earnings etc.
The Balance Sheet is a useful tool to help you analyse the financial health of a company – its assets/liabilities are displayed (with further details usually in the notes to the accounts) for you to make an assessment.
So for example, if you’re looking at investing in a company that has little to no debt, the correct financial statement to look at would be the Balance Sheet (or Statement of Financial Position), under the liabilities section.
Or, if you’re looking to determine how much inventory your company has at the stated point in time, look no further than then Current Assets section of the Balance Sheet, once again!