What is a Balance Sheet?
The Balance Sheet provides a snapshot of a company’s assets, liabilities and equity at a given point in time. This enables stakeholders to assess the financial health and operational results of the business. Moreover, a Balance Sheet is important because:
- It maintains healthy relationships with stakeholders; which includes employees, investors, creditors, regulators, vendors.
- It helps stakeholders understand whether the business is profitable, capable of repaying its debts, and financially stable enough to continue operations.
- It allows business owners to secure trust and investment, manage credit, and maintain supplier relationships.
Balance Sheet Calculation
The fundamental equation underlying a Balance Sheet is simple yet profound: Liabilities + Equity = Assets
This equation, often referred to as the accounting equation, ensures that every financial transaction affects both sides of the Balance Sheet – maintaining the balance.
For example: When a business issues a £10,000 bond and receives cash, it records a £10,000 increase in both its assets (cash) and liabilities (bonds payable), keeping the equity unchanged
Balance Sheet Components
- Assets: These are resources that the business owns and expects to bring future economic benefits. They fall into two categories: current and non-current.
- Current Assets: These include cash, accounts receivable, and inventory, all of which the business expects to convert into cash within a year.
- Non-Current Assets: These encompass land, buildings, and intangible assets like patents, which provide long-term value and do not convert quickly into cash.
- Liabilities: These are what the business owes to others. They split into two types:
- Current Liabilities: These include obligations that the business needs to settle within a year, such as accounts payable and the current portion of long-term debt.
- Non-Current Liabilities: These are obligations that the business will pay beyond a year.
- Equity: This represents the owner’s interest in the company, also known as shareholder’s equity or owner’s equity. Additionally, it consists of elements like ordinary shares, additional paid-in capital, and retained earnings, reflecting the net assets shareholders own after subtracting all liabilities.
Interaction with other Financial Statements
The balance sheet is interconnected with other financial statements:
- The profit and loss account, which shows the company’s revenues and expenses over a period, impacts the equity reported through net income or loss.
- Retained earnings increase with net income and decrease with any dividends paid.
- The cash-flow statement, which tracks the cash inflows and outflows from operating, investing, and financing activities, should align with the cash reported at the end of the period.
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