Balance sheet definition
Balance sheet meaning
The balance sheet is one of the three primary financial statements reported by every business. It provides insight into the company’s net worth and its financial position. Because of the structure, it provides an overview of the assets owned by the company along with business’ sources of finances. The balance sheet shows the level of liabilities a company has as well as the level of owner’s equity.
The balance sheet can be used by the stockholders, potential investors, and creditors in the process of company evaluation. It is used for performing ratio analysis which can show the liquidity levels of the company, accounts receivable turnover, inventory turnover, accounts payable turnover, financial leverage, and a variety of other information.
What is a balance sheet?
The balance sheet is a financial statement which is divided into two main sections: the assets side, and liabilities and stockholder’s equity side. Preparation of this financial statement should be in accordance with the accounting equation:
Assets = Liabilities + Equity
If this rule is not satisfied when preparing the balance sheet statement, then the statement will not be accepted by the stockholders and the relevant authorities. The notion behind the equation is that a company is financing its assets from the two main sources of funds: debt (liabilities) or investors (issuing stocks).
Balance sheet structure explained
Each side of the statement consists of specific accounts used when recording the different types of assets or sources of funds. The main categories of accounts on the assets side are current assets and long-term assets. Categorization of the accounts is based on the asset’s degree of liquidity. Therefore, the current assets would consist of cash, cash equivalents, account receivable, inventory, etc. Long-term assets refer to investments which cannot be liquidated in a year without incurring a high cost. Other long-term assets are machinery, property, plants, equipment, etc.
The Liabilities section lists the debt obligations of the company on the basis of their payment date. Liabilities which should be paid within a year are recorded as current liabilities. Debt obligations with longer maturity period are recorded as long-term debt. Examples of current liabilities are rent, tax, any interest payable, wages payable, etc. Example of long-term liabilities are the principal payments and interest payments on issued bonds.
Equity section records funds provided by the stockholder. The company can raise funds by issuing different types of stocks, such as common stocks and preferred stocks. These are recorded separately in this section of the balance sheet. Another item which is listed is the retained earnings. Retained earnings are the accumulated profit a company has earned in different periods. The company can either pay dividends to its stockholders or use the retained earnings to expand business activities.