A firm’s income statement tells us how it performed in a given period. The balance sheet resembles a picture taken at the end of that timeframe. It is an end-of-period snapshot of financials. The balance sheet shows what a company owns and what it owes. It shows how the business (large or small business) invested its resources or assets. A balance sheet also shows where the money came from, or liabilities.

The academic name for a balance sheet is Statement of Financial Position (one of the three main financial statements).



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Every Statement of Financial Position, or balance sheet, has three major elements.

The three major elements of a balance sheet

  1. The company’s assets. These are resources the company has that should create future economic benefits. 
  2. The company’s liabilities. These are the company’s obligations from past events and business transactions. Settling these obligations will probably lead to future spending.
  3. The company’s equity. Stockholder equity is the owner’s interest in the company. You get this by subtracting liabilities from assets. Because assets minus liabilities equals the owner’s equity, we can also say:

Assets = Liabilities + Equity

This is the fundamental accounting equation. We need to remember this equation when we work with or make a balance sheet.

We can summarize this equation differently. Say that the left side shows the resources controlled by a company, or its assets, while the right side shows how the firm paid for these resources. The company got money from third parties or by increasing the owners’ share in the business.

Either way, the balance sheet should always “balance” without exception.

Looking at a sample balance sheet

Remember that the statement of financial position is for a specific time. The ABC Corporation creates its Statement of Financial Position on 31st December each year. We say that the balance sheet date is the 31st of December.

ABC Corporation
Statement of Financial Position as at 31st December 20XX
    Current Year Previous Year
    20XX 20XX -1
ASSETS      
Cash and cash equivalents       1 248           793
Trade and other receivables     10 764       11 654
Inventories       2 135         1 577
Intangible assets           39               4
Property, plant and equipment           822           757
Deferred tax assets             70             91
Total Assets           15 078       14 876
   
LIABILITIES  
Trade and other payables       4 700         4 998
Short-term borrowings           10               2
Income tax payable           18             31
Long-term borrowings           88             55
Retirement benefit obligations             100           100
Total Liabilities         4 916         5 186
   
EQUITY  
Share capital       1 378         1 378
Retained earnings       8 784         8 312
Total Equity           10 162         9 690
   
Total Equity and Liabilities       15 078       14 876

The three major elements of a balance sheet are total assets, total liabilities, and total equity. The sub-totals in each section are also important. These include current and non-current assets and current and non-current liabilities. There must be a reason for highlighting them, right?

Of course, there is!

It is important to classify elements right from the start. The simplest way to tell apart current and non-current balance sheet items is to set a deadline. This can be one-year after the balance sheet date. 

Balance sheet assets

If a company holds assets to use within one year, they are current assets. The company can trade or expect to sell, use, or otherwise turn these assets into cash. There are common current assets lines in every Statement of Financial Position. These are inventories, trade receivables, cash, and cash equivalents.

Say we expect to collect receivables from clients by the 30th of June next year. We would report them as trade receivables (account receivables) in the Current Assets Section.

Did you notice that we also have a Trade Receivables line in the Non-Current Assets section? Why is that?

Some receivables may be overdue or may come later than 31st December next year. That’s longer than the one year threshold, right?

Assets a company plans to use longer are non-current, long-term, or long-lived assets (also referred to as fixed assets). Common examples are property and equipment the company owns. They could also be intangible assets or deferred tax assets. Please be aware that a company’s tangible assets are depreciated on an annual basis to account for their usage and decrease of value. Every year the book value of property, plant, and equipment is reduced by the amount of accumulated depreciation.

Balance sheet liabilities

If a company will settle a liability within a year after the reporting date, it is a current liability. One example is trade payables (account payables). Companies usually pay their suppliers in 30 to 90 days, depending on agreements. Even though the company may use other payment periods, they are usually shorter than one year. That’s why trade and other payables go in the Current Liabilities section.

Current income tax payable is normally due three months after the balance sheet date. This means current income tax payable is in the current liabilities section too. So are borrowings, which are due in twelve months.

Finally, we have non-current liabilities. The company expects to settle these more than one year from the balance sheet date. Non-current liabilities can be long-term borrowings and retirement benefit obligations owed to employees.

Let’s recap

In this article, we showed what a balance sheet is. We explained why the balance sheet represents a snapshot of a firm’s financials. We went through the main balance sheet components. We looked at a thorough balance sheet example.

Hopefully, this was a useful read. You will be able to answer the question ‘what is a balance sheet’ with ease and you can learn even more in my Udemy course.

The post What is a Balance Sheet? Understanding a Balance Sheet Example appeared first on Udemy Blog.

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