Understanding the Balance Sheet: Purpose, Features, and Key Components

Balance Sheet

Balance Sheet is a statement which sets out the assets & liabilities of a firm as at certain date. It shows the financial position of the business as at given time. Excess of assets over outside liabilities is the capital and it indicative of the financial soundness of a company. It is prepared from real account & personal accounts. The debit and credit balance of those ledger account which have not been closed by transfer to trading & profit and loss account are shown in balance sheet. An importance component of financial statements. Presents a snapshot of financial position of a current business at a particular point of time.

Definition - “Balance sheet is a statement prepared with a view to measure the exact financial position of a business on a certain fixed date”

According to H.G. Guthmann “The Balance sheet might be defined as the dual financial picture of an enterprise, depicting, on the one hand, the properties that it utilises and on the other hand the source of those properties”

A financial statement that shows a company’s financial position at a specific date. 

• Follows the accounting equation: Assets = Liabilities + Assets

Purpose and need of balance sheet

1. To ascertain the financial position of business as a particular point of time. 
2. To know the amount of assets it owns under various heads say debtors, fixed assets.
3. To know the amount of liabilities it owes to outsiders and the proprietors.
4. To helps in determining whether the firm is solvent or not.

Feature of Balance Sheet

1. It shows financial position of a business.
2. It is prepared at a particular date or a particular period
3. It is prepared after the prepared trading account and profit & loss account
4. Balance sheet is not an account financial statement of assets and liabilities
5. Totals of assets side and liabilities if not match – error.
6. Balance sheet is a statement and not an amount.
7. It is prepared at a particular date and not for a particular period
8. It is prepared after profit and loss account 
9. Balance sheet shows financial position of business as a going concern.

How to prepare a Balance Sheet?

1. It is a statement prepared to know the financial position of a business (i.e., financial strengths & weakness of a business on a given date)
2. It is revealed by the assets & liabilities
3. Assets: All tangible and intangible items which have a realisable value
4. Liabilities: All dues and loans payable
5. Assets (-) Liabilities = Capital (This would show the strength or net worth of the business)

Components of the Balance Sheet

Main Component	Description	Sub-Components	Examples
1. Assets	Economic resources owned by the company, expected to provide future benefits.	a. Current Assets: Assets expected to be converted into cash or used up within one year.	Cash, Accounts Receivable, Inventory
		b. Non-current Assets: Long-term assets that provide benefits over a period longer than one year.	Property, Equipment, Intangible Assets (Patents, Trademarks)
2. Liabilities	Obligations that the company owes to external parties.	a. Current Liabilities: Debts or obligations due within one year.	Accounts Payable, Short-term Loans
		b. Non-current Liabilities: Debts or obligations due after more than one year.	Long-term Debt, Bonds Payable
3. Equity	The owners’ claim on the business after all liabilities have been paid (residual interest in the assets after deducting liabilities).	a. Common Stock: Value of shares issued to investors.	Share Capital
		b. Retained Earnings: Accumulated net income that has not been distributed as dividends.	Retained Profits

Format of balance sheet

Basic Balance Sheet Format

Liabilities	Amount	Assets	Amount
Sundry Creditors	…	Cash in Hand	…
Bills Payable	…	Cash at Bank	…
Bank Overdraft	…	Bills Receivable	…
Employees Provident Fund	…	Sundry Debtors / Book Debts	…
Loans and Advances Taken (Cr.)	…	Loans and Advances Given (Dr.)	…
Reserves or Reserve Fund	…	Closing Stock	…
Capital	…	Loose Tools	…
Add: Interest on Capital	…	Investments	…
Add: Net Profit	…	Furniture and Fittings	…
Less: Drawings	…	Plant and Machinery	…
Less: Income Tax	…	Land and Building	…
Less: Interest on Drawings	…	Business Premises	…
Less: Net Loss	…	Patents and Trademarks, etc.	…
Total	…	Goodwill	…
		Total	…

Grouping & Marshalling (Arrangement) of Assets & 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. Assets and liabilities are shown in balance sheet either. 

1. In order of liquidity – On asset side more liquid is written first (current assets), less liquid assets are written test (fixed assets), On liquidity side, short term liabilities are written first and long-term liabilities are written last.
2. 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.

It is used along with other important financial statements such as the income statement and statement of cash flows in conducting fundamental analysis or calculating financial ratios. Balance Sheet has two main heads –Assets and Liabilities. Where, Assets are those resources or things which the company owns and Liabilities on the other hand are debts or obligations of a company.

Balance Sheet

Assets	Amount	Liabilities & Equity	Amount
Current Assets		Current Liabilities
- Cash and Cash Equivalent	XXXX	- Accounts Payable	XXXX
- Accounts Receivable	XXXX	- Short-term Debt	XXXX
- Inventory	XXXX	- Wages & Salaries	XXXX
- Prepaid Expenses	XXXX	- Taxes Payable	XXXX
Total Current Assets	XXXX	Total Current Liabilities	XXXX
Non-Current Assets		Non-Current Liabilities
- Property, Plant & Equipment (PPE)	XXXX	- Long-Term Debt	XXXX
- Intangible Assets (Patents, Trademarks)	XXXX	- Deferred Tax	XXXX
- Investments	XXXX
Total Non-Current Assets	XXXX	Total Non-Current Liabilities	XXXX
Total Assets	XXXX	Total Liabilities	XXXX
		Equity
		- Common Stock	XXXX
		- Retained Earnings	XXXX
		- Additional Paid-in Capital	XXXX
		Total Equity	XXXX
		Total Liabilities + Equity	XXXX

Understanding Assets and Liabilities

Category	Type	Description	Examples / Notes
Assets	Current Assets (≤ 1 year)	Resources expected to be converted into cash or used within a year.
	a. Accounts Receivable	Amounts owed by customers (high liquidity).	Immediate cash inflow expected.
	b. Inventory	Unsold goods held for sale.	Includes raw materials, work-in-progress, and finished goods.
	c. Prepaid Expenses	Advance payments for future services.	Examples: Rent, insurance, subscriptions.
Assets	Non-Current Assets (> 1 year)	Long-term resources used in business operations.
	a. Property, Plant & Equipment (PPE)	Tangible assets used for production.	Examples: Buildings, machinery, vehicles.
	b. Intangible Assets	Non-physical assets providing future benefits.	Examples: Patents, trademarks, goodwill.
	c. Investments	Long-term financial holdings.	Example: Shares or bonds in other companies.
Liabilities	Current Liabilities (≤ 1 year)	Obligations due within one year.
	a. Accounts Payable	Amounts owed to suppliers.	Short-term obligation.
	b. Short-Term Debt	Loans or overdrafts repayable within a year.	Includes bank overdrafts, short-term loans.
	c. Wages & Salaries Payable	Amounts owed to employees.	Payments due for work done.
	d. Taxes Payable	Pending tax obligations.	Income tax, GST, etc.
Liabilities	Non-Current Liabilities (> 1 year)	Long-term obligations beyond one year.
	a. Long-Term Debt	Loans or bonds repayable over several years.	Includes bank loans, bonds, mortgages.
	b. Deferred Tax Liabilities	Taxes due in the future.	Created due to temporary timing differences.
	c. Other Long-Term Liabilities	Other future obligations.	Examples: Pension funds, lease obligations.
Equity	Owner’s Equity / Shareholders’ Equity	Represents ownership interest in the company.
	a. Common Stock	Capital raised from shareholders.	Represents ownership shares.
	b. Retained Earnings	Profits kept in the business after dividends.	Reinvested for growth or debt repayment.
	c. Additional Paid-In Capital	Extra money received from investors over share’s par value.	Often occurs during stock issuance.
	d. Treasury Stock	Shares repurchased by the company.	Reduces total shareholders’ equity.

Assets

1. Cash & Equivalent → Most liquid asset
2. Accounts Receivable → Customer dues
3. Inventory → Unsold goods
4. Prepaid Expenses → Advance payments (rent, insurance)
5. Property, Plant & Equipment (PPE) → Long-term business assets
6. Intangible Assets → Patents, trademarks, goodwill
7. Investments (Long-term) → Stakes in other companies

Liabilities & Equity

1. Accounts Payable → Money owed to suppliers
2. Short-Term Debt → Immediate financial obligations
3. Wages Payable → Employee salaries due
4. Taxes Payable → Pending tax payments
5. Long-Term Debt → Loans & bonds payable later
6. Deferred Tax Liabilities → Future tax obligations
7. Common Stock → Funds raised from investors
8. Retained Earnings → Profits after paying dividends
9. Additional Paid-in Capital → Extra money above stock price

Key balance sheet ratios

1. Current ratio = current assets ÷current liabilities, it measures liquidity
2. Quick ratio = (current assets – inventory) ÷ current liabilities, strictly test of short-term liquidity.
3. Debt to equity ratio = total liabilities ÷ current liabilities, measures financial leverage
4. Asset turnover ratio = revenue ÷ total assets, shows efficiency in asset utilization
5. Equity ratio = total equity ÷ total assets, indicates financial stability.

Related Posts

Previous

Next