Balance Sheet – Meaning, Components, Format and How to Prepare

What is balance sheet?

Balance sheet refers to a financial statement which reveals the complete financial position of the company for a given date. A company’s balance sheet tells you the details of assets, liabilities and owners’ equity for the business. In simple words, the balance sheet is a statement which tells you the assets of the business, the money others need to pay you and the debt you owe others including the owner’s equity.

Balance sheet is one of the important financial statement used for making business decisions. Balance sheet is used by various stakeholders like management, employees, investors, creditors, banks, regulatory authorities, tax authorities etc.

Balance sheet objectives

A balance sheet is also called as a top financial statement. Let’ us understand this by knowing the purpose and objective of the balance sheet. The following are some of the key objectives of the balance sheet:

• It helps in ascertaining the financial position of the business on a given day.
• Details of owner’s equity can be determined
• The information from the Balance sheet helps you create provision for future loss/contingencies by creating reserves
• It provides a snapshot of business health including the economic resources the business owns, owes, and the sources of financing for those resources.
• Ascertain if the business is financially autonomous and therefore solvent
• Determine the financial liquidity of the business

Balance sheet components

Balance sheet components are broadly divided into ‘Assets’ and ‘Liabilities’. Each of this balance sheet components consists of several sub-components. The following are balance sheet items:

As shown in the above balance sheet illustration, assets are broadly classified into fixed assets, investments and current assets. Similarly, liabilities are classified as owner’s capital, long-term debts and current liabilities. Let’s understand these balances sheet items in detail.

Assets

Something that an entity has acquired or purchased and owned, regarded as having value and available to meet debts, commitments or legacies. Assets are further broadly classified as:

• Fixed Assets

Assets which are purchased for long-term use and are not likely to be converted quickly into cash, such as land, buildings, and equipment.

• Current Assets

A current assets are those assets which can be converted into cash within one year. Examples of current assets are, Cash, Bank balances, Investments, Deposits, Accounts receivables and Inventory

Liabilities

Liabilities are the obligations or Debts payable by the enterprises in future in the form of money or goods. Liabilities are further broadly classified as:

• Equity or Capital:

Money invested in the business to generate income.

• Loans & Borrowings

Money borrowed from a financial institution or from others to be utilized in business for generating income and managing the day to day affairs of the business. Ex: Bank Overdraft, Term Loan.

• Current Liabilities

Current liabilities are debts or obligations payable within a short period of time or one year. Ex: short term debt, trade payables, taxes due, accrued expenses.

Balance sheet format

Below is the balance sheet format

As illustrated above, on the left side of the balance sheet format, all the assets are shown followed with the sub-components of assets. On the right side of the balance sheet format, liabilities followed with sub-components are displayed.

Balance sheet equations

As shown in the above balance sheet format, the balances of total liabilities and assets owned by the business always match. This implies that the total value of assets always adds up to the total liabilities of the business. The following are balance sheet equations:

• Assets = Liabilities + Owner’s Equity: This balance sheet equation tells you that all the assets owned by the business are either sponsored using the owners’ equity or the amount which company should owe others like suppliers or borrowings like loans
  
  
• Liabilities = Assets – Owner’s Equity: The difference of assets and owner’s investment into business is your liabilities which you owe others in the form of payables to suppliers, banks etc
  
  
• Owners’ Equity = Assets – Liabilities: This equation reveals the value of assets owned purely by owner equity

How to prepare a balance sheet?

Balance sheet preparation involves multiple steps to consolidate the accounting records and preparing various statements.

The following are the steps to prepare a balance sheet:

• Posting of accounting records from journal books to individual ledge accounts
• Preparing ledger accounts and ascertaining the closing balance of each ledger accounts
• Preparing trial balance summarizing the closing balance of ledger accounts
• Computing the debit and credit balance in trial balance to ensure the journal and ledger posting are arithmetically accurate.
• If there is any difference in trial balance, errors need to be identified and corrected
• Post correction and fixing the errors, an adjusted trial balance needs to be prepared
• Preparing trading and profit & loss account by considering all the ledgers having income and expenses nature from trial balance
• Finally, preparing a balance sheet in the format shown above by considering all assets and liabilities from the trial balance.

Balance sheet prepared by modern day business

Today, most businesses have automated balance sheet preparation using accounting software. Businesses believe using accounting software helps in saving time and efforts involved in managing books and preparing financial statements such as balance sheet. Further, the use of accounting software facilitates in generating comparative balance sheet – across periods and branches and consolidated balance sheet of all the branches or business verticals.