Financial Statements – What Is a Balance Sheet?

Financial statements are described as being the final outcome of transactions between a specific entity and other companies and individuals. Transactions include sales, purchases, and general cash flows. There are several types of financial statements, which include, balance sheet, income statement, statement of cash flows, and statement of changes in owner’s equity. This article will examine the one of the most important financial statements, the balance sheet.

Balance Sheet

The balance sheet is a statement that describes an entity’s financial position at a certain point in time, usually at the end of an accounting period. It depicts the organizations assets, liabilities, and owners equity.

The balance sheet equation is as followed,
Assets = Liabilities + Owners Equity.

The two sides of the equation balance out, hence why the statement is called the balance sheet.

Assets are the economic benefits that will be acquired and controlled by an organization as a result of past transactions. Assets are tangible; they include cash, accounts receivable, inventory, and equipment. Assets can be broken down into current, and long term. Current assets, such as cash, and accounts receivable, are assets that are or can be transformed into cash or benefit the company within one year. On the other hand, long-term assets, which can include land, inventory and equipment, are paid off and will benefit the company over an extended period of time. Accumulative depreciation is used on balance sheets to explain how the cost of long-term assets are “used up” during the process of running a business. The cost is spread over the life of the asset. For example, say a piece of machinery cost $50,000, and the useful life of the machine is 20 years, therefore in the first year the accumulative depreciation for the equipment is $2,500.

Liabilities can simply be explained as the amounts owed to other organizations, such as the transfer of assets, or services that need to be provided. Liabilities are also made up of current and long-term. Current liabilities are those that will be paid within one year, these include accounts payable, notes payable, current maturities of long-term debt and payroll taxes. Long-term debt is that which is paid off over an extended period of time.

Owner’s equity, also called net assets, is the right of ownership the owners of the organization have after subtracting liabilities. Some examples of owner’s equity include, common stock, additional paid in capital, and retained earnings. Common stock is issued as an investment in the business. For example, in corporations, stockholders are ultimately the owners, they claim all assets after liabilities and preferred stock claims are satisfied. Additional paid in capital is defined as the leftover amount paid by the investor over the stated value of the shares sold. Finally, the retained earnings are the net income that is not be distributed as dividends to owners or an organization.

So, what is the purpose of a balance sheet? First, business owners use balance sheets in order to analyze the strength and capabilities of their business. For example, is the business ready to expand? Or, should the business take immediate steps to strengthen cash reserves? Also, balance sheets describe trends, especially in the area of accounts receivables and payables. For instance, is debt in payables being paid, and is debt in receivables being received in a reasonable amount of time. Finally, balance sheets are examined by banks, investors, and vendors to determine the amount of credit they will give the entity.