“What are Balance Sheets?”

 

There are four basic financial statements: income statements, cash flow statements, statements of retained earnings, and – the topic of this article – balance sheets.

 

What is its purpose?

 

A “balance sheet” acts as a statement of a business’s financial position that primarily lists the assets, liabilities, and owners’ equity at a specific point in time. Put simply, the purpose of a balance sheet is to illustrate the net worth of a business.

 

These sheets aid business stakeholders and analysts in evaluating the financial position of a company, as well as its ability to pay for its needs of operation. One can also use a balance sheet to figure out how they can meet their financial obligations. Moreover, they can help determine the best ways to use credit to finance certain operations.

 

The balance sheet may possess details from previous years, which will allow you to conduct back-to-back comparisons. This data will provide assistance in tracking your performance and pinpoint various ways to amplify your finances and see what sections need improvement.

 

Main components

 

  • Assets: In the section dedicated to assets, accounts are typically listed from top to bottom in order of their liquidity. In other words, based on the ease of their conversion to cash. They are divided into current assets, which can be converted to cash in the span of a single year or less, and non-current or long-term assets, which cannot be converted to cash.
  • Liabilities: This is the money that a company owes to outside parties, ranging from bond interests it has issued to creditors to rent to bills it has yet to pay to suppliers. “Current liabilities” are due within one year and are listed in order of their due date. “Long-term liabilities” are those that are due at any point following one year.
  • Shareholders’ equity: This is the money that is attributed to the owners of a business. In other words, its shareholders. It is also referred to as “net assets” because it is equal to a company’s total assets minus its liabilities. That is to say, the debt it owes to non-shareholders.

 

Formula

 

A balance sheet adheres to the accounting equation below:

 

Assets = Liabilities + Shareholders’ Equity

 

This is an intuitive formula, with a company needing to pay for all that it owns (assets) in one of two ways. They either borrow money (taking on liabilities) or acquire it from investors (issuing shareholders’ equity).

 

Assets, liabilities and shareholders’ equity each contain numerous smaller accounts that spell out the details of a company’s finances. As they depend on the industry, these accounts vary widely. Moreover, the same terms can possess different implications based on the nature of the business. However, for the most part, there are still a few common components that investors may encounter.