Updated July 15, 2023
Definition of Balance Sheet
Balance sheet rightly helps the users to understand the financial stability and position of a company as a balance sheet is the most crucial report which shows the financial standings and strength of a company at a point of time by comprising the data of Assets, liabilities, and shareholder’s equity of the company at that point of time (generally Balance sheet is prepared at month-end or quarter-end or year-end).
Explanation
The balance sheet is a snapshot of a company’s financial position and status at a particular time (as of the date), which helps the stakeholders to quantify the company’s financial strengths. The balance sheet is prepared based on an equation called Balance Sheet Equation, which is;
This is the principle on which the whole balance sheet is made. Balance sheet records in three proportions; one is the Asset, which will always equal the company’s total liabilities as of the date summed up with all the funds acquired from the shareholders and any retained earnings accumulated by the company.
How to Read a Balance Sheet?
As per the Balance sheet equation, the Balance Sheet could be divided into three components, and these components could also be sub-divided into parts which could be summarised as follows:
- Assets: Current Assets, Non-Current Assets, or Long Term Assets
- Liabilities: Current Liabilities, Non-Current Liabilities, or Long Term Liabilities
- Shareholder’s Equity: Common Shares & Retained Earnings
To understand the balance sheet, it is vital to understand these components and their sub-categories.
1. Assets: Assets are used to operate the business and provide future economic benefits to the entity. These are classified into two categories:
- Current Assets: Current Assets are typically liquid assets that could be converted into cash or cash equivalents within one year. Current Assets Include-
- Inventories: The stock in trade is available on the date of the balance sheet, which the company is used to selling. Inventories include raw materials, finished goods, intermediary goods (which are still progressing to completion), and trading goods.
- Accounts Receivable: These are the amounts that have been earned by the company through its sales but not received yet, and the bad debt also has been written off from the amount, which is not expected to be received in the future.
- Cash & Cash Equivalents: These are entirely liquid assets, like cash & bank balance.
- Others may include short-term investments, short-term advances, prepaid expenses, etc.
- Non-Current Assets (Long Term Assets): Long-term assets are where companies have expended the most capital for long-term returns. These include:
- Property, Plant & Equipment: These are the Fixed Assets having more than a year of life, i.e., machinery, office equipment, land, building, etc.
- Long-Term Investments.
- Intangible Assets, i.e., goodwill, patent, know-how, etc.
2. Liabilities: The company owes the expenses to others. It could be categorized into two:
- Current Liabilities: These are the liabilities that need to be paid within one year. These include short-term borrowing, trade payables, interest payables, etc.
- Non-Current liabilities: These are the liabilities that need to be paid or have a credit period of more than one year. These include liabilities that are not covered in current liabilities.
3. Shareholder’s Equity: This is also termed net worth or the company’s overall value. It includes the common equities received from the shareholders and has been issued to them, and it also includes Retained Earnings.
- Share Capital & Common Stock: It shows the total value for which investors have invested in the company and the value of stocks issued to shareholders.
- Retained Earnings: These are the funds accumulated through profit remains of companies throughout running a business which have been saved and might be used in the industry or paid off as dividends to the shareholders.
Through this information and the data provided in the Notes to Accounts and through different types of ratio analysis, the users can test the financial stands of the business and the efficiency of running the company.
Sample Balance Sheet (with Excel Template)
The Excel template of the same balance sheet has also been provided.
| Balance Sheets | ||
| (Anonymous Balance Sheet) | ||
| June 30, | 2019 | 2018 |
| Particulars | Amount (In millions $) | Amount (In millions $) |
| Assets | ||
| Current assets: | ||
| Cash and cash equivalents | 11,000.00 | 11,500.00 |
| Short-term investments | 1,20,000.00 | 1,15,000.00 |
| Total cash, cash equivalents, and short-term investments | 1,31,000.00 | 1,26,500.00 |
| Accounts receivable | 30,000.00 | 25,000.00 |
| Inventories | 2,000.00 | 2,500.00 |
| Other | 10,000.00 | 6,750.00 |
| Total current assets | 1,73,000.00 | 1,60,750.00 |
| Property and equipment | 35,000.00 | 30,000.00 |
| Operating lease right-of-use assets | 7,500.00 | 6,700.00 |
| Equity investments | 2,500.00 | 2,000.00 |
| Goodwill | 40,000.00 | 35,000.00 |
| Intangible assets, net | 7,500.00 | 8,000.00 |
| Other long-term assets | 15,000.00 | 7,500.00 |
| Total assets | 2,80,500.00 | 2,49,950.00 |
| Liabilities and stockholders’ equity | ||
| Current liabilities: | ||
| Accounts payable | 9,000.00 | 8,500.00 |
| Current portion of long-term debt | 5,500.00 | 4,000.00 |
| Accrued compensation | 6,500.00 | 6,000.00 |
| Short-term income taxes | 5,500.00 | 2,000.00 |
| Short-term unearned revenue | 30,000.00 | 26,000.00 |
| Other | 10,000.00 | 8,500.00 |
| Total current liabilities | 66,500.00 | 55,000.00 |
| Long-term debt | 65,000.00 | 70,000.00 |
| Long-term income taxes | 30,000.00 | 30,500.00 |
| Long-term unearned revenue | 4,500.00 | 3,500.00 |
| Deferred income taxes | 200 | 600 |
| Operating lease liabilities | 6,000.00 | 5,500.00 |
| Other long-term liabilities | 7,500.00 | 5,000.00 |
| Total liabilities | 1,79,700.00 | 1,70,100.00 |
| Commitments and contingencies | – | – |
| Stockholders’ equity: | ||
| Common stock and paid-in capital | 75,000.00 | 70,000.00 |
| Retained earnings | 26,000.00 | 11,000.00 |
| Accumulated other comprehensive loss | -200 | -1,150.00 |
| Total stockholders’ equity | 1,00,800.00 | 79,850.00 |
| Total liabilities and stockholders’ equity | 2,80,500.00 | 2,49,950.00 |
In the sample balance sheet, we can see that the balance sheet can be segregated into three parts – Assets, Liabilities & Shareholder’s Equity, where Assets consist of Current Assets (cash & cash equivalents, short-term investments, Account receivables, inventories & others) and Non-Current Assets (Fixed Assets, intangible assets & others) totaling to $ 2,80,500 in the Year 2019 & 2,49,950 in the year 2018.
The second part is Liabilities consisting of current liabilities (short-term accounts payables and other liabilities) & Non-Current Liabilities (long-term liability, other long-term debts), amounting to $ 1, 79,700 in 2019 & $ 1, 70,700 in 2018.
The third part is Shareholder’s Equity consisting of common stocks and other retained earnings totaling $ 1 00,800 in 2019 & $ 79,850 in 2018. Which satisfies the balance sheet equation; for 2019 (same as the year 2018)
$ 280500 = $ 179700 + $ 100800
Conclusion
Knowing how to read a balance sheet is helpful for the users of the financial statement, as the statement of profit and loss only shows the profit earned by the company in that period. In contrast, the balance sheet shows the proper financial strength and weakness of the company and the capability of the company to make future profitability. This makes the users make the right decision regarding the entity’s course of business. With the statement of profit & loss and cash flow statement, the balance sheet becomes the complete financial statement that provides the users and investors with all the relevant information about the business and the company’s standing in the market.
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