A financial statement summarizes business assets, liabilities and capital (equity) at a specific point of time. A balance sheet along with the income statement and cash flow statement, make up a business’ financial statement. Reading a balance sheet is important for business owners as it reveals the health of their organization.
Formula for balance sheet
Assets = Liabilities + Capital (Equity)
It’s called a balance sheet because the assets and liabilities balance out. The balance reveals how much the business has to pay to its suppliers, bankers and other outside creditors, and how much it will receive from others (debtors), how much it owns as assets both fixed and current and how much capital and reserves are there as on a specific point of time, usually at the end of the financial year.
So, what are assets
- Obviously, cash has value. Asset is a balance sheet item that a firm owns. Assets are added or brought to benefit the operations of the business
- Accounts receivable are amounts owed to the business. These have value because they are converted into cash and help in a healthy cash flow
- Goods are brought and sold to customers. The inventory should be converted into accounts receivable and ultimately into cash or cash directly
- Businesses acquire fixed assets such as machinery, building, computers,vehicles, etc, to facilitate business
- Intangible assets which include brands, trademarks, patents are also assets that cannot be valued
Assets can be divided into two categories
Current Assets: Current assets can be converted into cash easily and have a life span of one year or less. These include cash and cash equivalents, accounts receivable and inventory.
Non-Current Assets: Non-current assets are something that cannot be converted into cash easily and are expected to turn into cash within a year or more. These includes tangible assets such as machinery, computers, buildings, land.
Intangible assets include goodwill, copyright, patents, etc.
What are liabilities
- Liabilities is an obligation that legally binds a business to settle a debt. This is on the other side of the balance sheet. Long-term liabilities are debts and other non-debt financial obligations which are due after a period of at least one year.
- Current liabilities where dues will become due or the business should pay within a year. These includes both short term borrowing and long term borrowing (the amount of money by way of installments payable during the current year).
Owner’s equity is the difference between total assets and total liabilities. It represents the amount by which a business is financed. It includes capital and retained earnings. The owner has a positive financial interest only if the businesses asset exceeds its obligations.
A number of techniques are used to analyze the information in the balance sheet through financial ratio analysis. Analyzing the balance sheet, using financial ratios can give you a better idea of the financial health and its operational efficiency.
Balance sheet is the most crucial sheet to every business. This sheet talks about your assets and liabilities management. Assets is the property you have with you and liabilities is the money you owe to the others. It will clearly show you from where you would receive money and to who all you need to pay. So check your balance sheet regularly, tally the amount to check for any errors if any. A balance sheet will help you keep track of your finances and help you in running your business effectively.