Understanding the Balance Sheet: Meaning & Key Features for Beginners

Introduction

This forms the second part of the final accounts. It is a statement showing the financial position of a business. Balance sheet is prepared by taking up all personal accounts and real accounts (assets and properties) together with the net result obtained from profit and loss account. Balance sheet is not an account but it is a statement prepared from the ledger balances. So, we should NOT prefix the accounts with the words "To" and "By".

Balance Sheet

The balance sheet is a statement that shows the financial position of the business. It records the assets and liabilities of the business at the end of the accounting period after the preparation of trading and profit and loss accounts.

Balance sheet is defined as "a statement which sets out the assets and liabilities of a business firm and which serves to ascertain the financial position of the same on any particular date".

Balance sheet is a statement which sets out the assets and liabilities of a firm as at certain date.
It shows the financial position of the business as at a given time
Excess of assets over outside liabilities is the capital and is indicative of the financial soundness of a company
It is prepared from real accounts and personal accounts
The debit and credit balance of these ledger accounts which have not been closed by transfer to trading and Profit & loss account are shown in Balance sheet.

Features of Balance sheet

The features of a balance sheet are as follows

It is regarded as the last step in final accounts creation
It is a statement and not an account
It consists of transaction recorded under two sides namely, assets and liabilities. Assets are placed in the left-hand side, while the liabilities are placed on the right-hand side
The total of both sides should always be equal
The balance sheet disclosed financial position of the business
It is prepared after trading and Profit & loss account is prepared.

Importance of Balance Sheet

Balance sheet analysis can say many things about a company’s achievement. Few essential factors of the balance sheet are listed below –

Creditors, investor and other stakeholder use this financial tool to know the financial status of a business.
It used to analyse a company’s growth by comparing different years
Company’s balance sheet analysis can deduct business expansion and future expenses.

What is the purpose of balance sheet?

The main purpose of the balance sheet is to show a company’s financial status. This sheet shows a company’s assets and liabilities along with the money invested in the business. This statement is required to analyse the financial status information for several consecutive periods.

Format of Balance Sheet

The Balance sheet of a business concern can be presented in the following two forms

Horizontal form or the Account form
Vertical form or Report form

Horizontal form of Balance Sheet:

The left-hand side of the balance sheet is an asset side and the right side is a liabilities side. All accounts having debit balance will appear in the asset side and all those having credit balance will appear in the liability side.

Balance Sheet of ………. As on ……

Liabilities	Amount	Assets	Amount
Sundry Creditors	…	Cash in hand	…
Bills Payable	…	Cash at Bank	…
Bank Overdraft	…	Bills Receivable	…
Employees Provident Fund	…	Sundry Debtor or Book Debts	…
Loans and Advance Taken (Cr.)	…	Loans and Advance Given (Dr.)	…
Reserve or Reserve Fund	…	Closing Stock	…
Capital		Loose Tools	…
Add Interest on Capital		Investment	…
Add Net Profit		Furniture and Fittings	…
Less Drawing		Plant and Machinery	…
Less Income Tax		Land and Building	…
Less Interest on Drawing		Business Premises	…
Net Loss	…	Patents and Trademarks etc.	…
		Goodwill	…

Vertical from of balance Sheet

In this, balance sheet is presented in a statement from

Balance sheet as on ….

Particulars	Amounts	Amounts
Current Assets
Stock in Trade	…
Sundry Debtors	…
Prepaid Expenses	…
Accrued Income	…
Bills Receivable	…
Cash in Hand	…
Cash at Bank	…
Total Current Assets		XXX
Less: Current Liabilities
Sundry Creditors	…
Bills Payable	…
Bank Overdraft	…
Outstanding Expenses	…
Total Current Liabilities		XXX
Net Working Capital (Current Assets – Current Liabilities)		XXX
Add Fixed Assets	…
Goodwill	…
Land and Building	…
Plant and Machinery	…
Furniture	…
Investment	…
Total Fixed and Intangible Assets		XXX
Total Assets		XXX
Less: Long Term Liabilities
Debenture	…
Loans	…
Total Long-term liabilities		XXX
Net Assets		XXX
Owners Capital	…
Reserves and Surplus	…
Shareholder’s Funds		XXX

Classification of Assets and Liabilities

Assets

Assets represent everything which a business owns and has money value. In other words, asset includes possessions and properties of the business. Asset are classified as follows:

Tangible Assets: Assets which have some physical existences are known as tangible assets. They can be seen, touched and felt, e.g. Plant and Machinery . Tangible assets are classified into

Fixed assets: Assets which are permanent in nature having long period of life and cannot be converted into cash in a short period are termed as Fixed assets.
Current assets: Assets which can be converted into cash in the ordinary course of business and are held for a short period is known as current assets. For example, cash in hand, cash at bank, sundry debtors etc.

Intangible Assets: The assets which have no physical existence and cannot be seen or felt. They help to generate revenue in future, e.g. goodwill, patents, trademarks etc.

Liabilities

The amount which a business owes to others is liabilities. Credit balance of personal and real accounts together with the capital account are liabilities.

Long Term Liabilities : Liabilities which are repayable after a long period of time are known as Long Term Liabilities. For example, capital, long term loans etc.
Current Liabilities : Current liabilities are those which are repayable within a year. For example, creditors for goods purchased, short term loans etc.

Grouping and Marshalling (Arrangement) of Assets and Liabilities

Grouping means putting items of a similar nature under a common accounting head. The arrangement of assets and liabilities in a particular order in balance sheet is called Marshalling.

The term ‘Marshalling’ refers to the order in which the various assets and liabilities are shown in the balance sheet. The assets and liabilities can be shown either in the order of liquidity or in the order of permanence.

Assets and liabilities are shown in balance sheet either.

In order of liquidity
In order of permanence

In order of liquidity

Liquidity means convertibility into cash. Assets will be said to be liquid if it can be converted into cash easily, they are placed at the top of the balance sheet. Liabilities are arranged in the order of their urgency of payment. The most urgent payment to be made is listed at the top of the balance sheet. In simple terms, in order of liquidity - On assets side more liquid assets are written first (current assets), less (-) liquid assets are written last (fixed assets). On liability side short term liabilities are written first and long-term liabilities are written last.

In order of permanence

Assets which are to be used permanently in business and not meant to be sold are written first. Most liquid assets are written last. Liabilities are shown according to their permanency in business. Capital is shown first, then long term liabilities then short-term liabilities. This order is exactly the reverse of the above. Assets and liabilities are recorded in the order of their life in the business concern.

Balance Sheet Equation

An important thing to note about the Balance Sheet is that, the total value of the assets is always equal to the total value of the liabilities.

This is because the liability to the owner - capital, is always made up of the difference between assets and liabilities.

Thus, Assets = Liabilities + Capital

Capital = Assets - Liabilities

While preparing the trial balance in case it does not tally the difference is transferred to an imaginary account called as suspense account. In case the suspense account is not closed before the preparation of the final accounts then it has to be placed in the balance sheet, so that it can be rectified later. If suspense account has a debit balance it will appear as the last item in the asset side. In case it shows a credit balance it will appear as the last item in the liability side.

Final Accounts

Trading Account
Profit and loss Account
Balance Sheet collectively called Final Account.

Important Point Final Account

Trial balance should be prepared to ensure the total of two sides (debit and credit) are matching for arithmetical accuracy. If the trail balance does not match the difference is placed under the head ‘Suspense Account’ may have debit or credit balance. It is accordingly placed in assets side and liabilities side of balance sheet.

Items appearing in trial balance are shown either in trading account or P&L account or balance sheet. Items appearing outside the trial balance are shown at two places once in trading account or profit & loss account and once balance sheet following dual aspect concept. Example closing stock is shown in liabilities side of trading account and assets side of balance sheet.

It should be determined whether items on credit side of trial balance are incomes or liabilities or capital.

Income from business – credited to trading account
Other income – credited to profit and loss account
Liabilities are shown in liabilities side of balance sheet.

It should be determined whether items on debit side of trial balance are direct expense or indirect expense or assets.

Direct expense – debited to trading account
Indirect account – debited to profit and loss account

If assets are shown in assets side of balance sheet.

For example (without GST) from the following trial balance prepare trading and profit & loss account for the year ended 31st March 2023 and balance sheet as at that date

Particulars	Amount	Particulars	Amount
Debit Balance		Rent	8,000
Sundry Debtors	15,000	Salaries	20,000
Stock on 1^st April 2022	50,000	Drawing	20,000
Land and Building	1,00,000	Purchase	1,00,000
Cash in hand	16,000	Office Expense	25,000
Cash at bank	40,000	Plant and Machinery	57,000
Wages	30,000	Credit Balance
Bills Receivable	20,000	Capital	2,50,000
Interest	2,000	Interest	6,000
Bad debts	5,000	Sundry Creditors	70,000
Repairs	3,000	Sales	1,70,000
Furniture and Fixtures	15,000	Bills payable	40,000
Depreciation	10,000

On 31st March 2023 the stock was valued at 1,00,000

Solution

Trading and Profit & loss account for the year ended 31st March 2023.

Dr. Cr.
Particulars	Amount	Particulars	Amount
To Opening Stock	50,000	By Sales	1,70,000
To Purchase	1,00,000	By closing Stock	1,00,000
To Wages	30,000
To Gross Profit c/d	90,000
	2,70,000		2,70,000
To interest	2,000	By Gross Profit b/d	90,000
To Bad debts	5,000	By Interest	6,000
To Repairs	3,000
To Depreciation	10,000
To Rent	8,000
To Salaries	20,000
To Office Expense	25,000
To Net profit (transferred to capital)	23,000
	96,000		96,000

Balance Sheet as at 31^st March 2023

Liabilities		Amount	Assets		Amount
Current Liabilities			Current Assets
Sundry Creditors	70,000		Cash in hand	16,000
Bills Payable	40,000	1,10,000	Cash at bank	40,000
			Bills Receivable	20,000
Capital			Sundry Debtor	15,000
Opening Capital	2,50,000		Closing Stock	1,00,000	191,000
(less) Drawing	20,000
	2,30,000		Fixed Assets
(add) Net Profit	23,000	2,53,000	Furniture and fixtures	15,000
			Plant and Machinery	57,000
			Land and Building	1,00,000	1,72,000

		3,63,000			3,63,000