Balance Sheet: Meaning, Types, Components & Example - Happay (2024)

What is a balance sheet?

A balance sheet is a powerful financial statement that offers a precise picture of a company’s financial status at a specific time. It provides an insightful summary of the company’s assets, liabilities, equity, and the key elements of its financial health.

Who should use the balance sheet?

Anyone who wants to understand a company’s financial position clearly should use the balance sheet. This includes investors, creditors, business owners, financial analysts, and accountants.

Why do investors and creditors use a balance sheet?

Investors and creditors use balance sheets to examine a company’s creditworthiness and financial stability. In contrast, business owners and managers use it to monitor their company’s financial performance and make informed investment decisions.

Why do financial analysts and CFOs use a balance sheet?

Financial analysts use it to analyze a company’s financial trends and compare them to its competitors. They also use it to calculate key financial ratios, such as the debt-to-equity ratio, which helps them assess a company’s financial risk.

Why do accountants use a balance sheet?

Accountants use it to prepare other financial statements and ensure the company’s accurate and up-to-date financial records.

Quick Read: Financial Reporting: What It Is and Why It Is Important

Why is a balanced sheet prepared?

A balance sheet helps various stakeholders of a company. It helps investors, creditors, finance analysts, auditors, etc., understand a company’s financial health and stability.

It is prepared because-

• It provides a complete overview of an organization’s financial health at any given time
• It helps examine the status of the solvency or liquidity of the company.
• It also assists in determining the company’s ability to meet its financial obligations.
• It allows the analysts to examine the company’s financial health and performance.
• It facilitates comparisons with previous periods and other companies in the same industry.
• It gives you the information crucial for making informed investments, expansions, and operations decisions.
• Helps in identifying potential areas of risk for the company.

What happens if you don’t prepare a balance sheet for your company?

While preparing financial statements may not spark joy in everyone, neglecting to prepare a balance sheet for your company could lead to less-than-pleasant consequences.

Here’s what could happen if you skip out on this essential financial task:

• With a balance sheet, impressing potential investors with your fiscal responsibility will be easier.
• Your company’s financial performance will be harder to track than a squirrel in a forest.
• Lenders may not be thrilled about loaning you money without a formal statement of your company’s financial position to demonstrate your financial stability.
• You could face legal and financial penalties if you fail to comply with accounting standards.

Quick Read: What is Accrual Accounting: Meaning, Principles, and Example

Uses of balance sheet

• It can help investors and lenders assess the risk of investing in or lending to a company by examining its assets, liabilities, and equity.
• It can also aid management in making decisions about resource allocation, such as how much to invest in capital expenditures or how much to pay out in dividends.
• By comparing balance sheets over time, stakeholders can track the financial progress of a company and identify any areas of concern.
• You can use it to calculate financial ratios, such as the debt-to-equity ratio, which can provide insight into a company’s financial leverage and solvency.
• Additionally, a balance sheet can be used to prepare other financial statements, such as the income statement, cash flow statement, etc.

Quick Read: Cash Flow Forecasting: Definition, Advantages, and How to Ace It

What expenses are included in the balance sheet?

Mostly, expenses are recorded on the income statement. However, there is one type of expense that gets recorded on the balance sheet- capital expenditure. These expenditures are typically related to long-term assets and are known as “capex.”

What is Capex?

Capex or capital expenditures are expenses used for acquiring or improving long-term assets like property or equipment. They’re not immediately expensed and instead are recorded on the balance sheet as an asset. For instance, a manufacturing company buying new equipment would be a capital expenditure and recorded on the balance sheet as an asset.

The relationship between Capex and the balance sheet

Capital expenses are recorded on the balance sheet as assets rather than as an expense on the income statement. Specifically, capital expenditures are recorded as property, plant, and equipment (PP&E) or as intangible assets, depending on the type of asset being acquired or improved.

The amount of capital expenditure is added to the cost of the asset on the balance sheet, and this cost is then depreciated over the useful life of the asset.

For example, if a company buys a new machine for $40,000, the cost of the machine is recorded on the sheet as a PP&E asset at the $40,000 purchase price.

Quick Read: The Ultimate Business Guide About Expense Management

Why is Capex recorded on the balance sheet?

Capex is recorded on the balance sheet as an asset as it allows the company to spread the cost over the life of an asset. This allows the company to more accurately reflect the true cost of using it as an asset over time. This also provides a more accurate picture of the company’s financial standing.

Types of balance sheet

There are three types of balance sheets-

• Comparative balance sheets: A comparative balance sheet compares the financial position of a company over two or more periods. By comparing two financial statements side-by-side, stakeholders can see changes in a company’s assets, liabilities, and equity over time.
• Vertical balance sheets: A vertical balance sheet lists a company’s assets, liabilities, and equity in a vertical column. It is useful for understanding the overall financial structure of a company, as well as the relative importance of each category of assets, liabilities, and equity.
• Horizontal balance sheets: A horizontal balance sheet lists a company’s assets, liabilities, and equity in a horizontal row. This format is typically used for comparative purposes, with the financial data for two or more periods displayed side-by-side.

Balance sheets also have two format types- report form and account form.

• Report Form: In this format, the assets are listed first, then the liabilities, and then equity. This is the most common format and is typically used by businesses in the United States.
• Account Form: In the account form, the assets and liabilities are listed side by side. This format is more commonly used in Europe and other parts of the world.

Understanding the balance sheet

A balance sheet is a financial statement that presents the financial position of a company at a specific point in time. It provides a summary of a company’s assets, liabilities, and equity.

Understanding this official statement of financial condition is essential for financial decision-making. It enables investors, analysts, and managers to evaluate a company’s economic viability, assess its risk levels, and identify potential growth opportunities. In other words, it concisely represents what a company possesses, what it owes, and what remains as its residual value for its shareholders.

The balance statement follows the accounting equation. This equation states that the value of total assets should always be equal to the value of liabilities plus equity. This means that the value of the total assets listed on the balance sheet should be the same as the total value of the liabilities and equity.

Quick Read: Expense Accounting

How does examining a company’s balance sheet help?

Examining a balance sheet can help you gain insights into the company’s financial health and performance. It can tell you crucial things about the company, like if the resources are being utilized well and if any changes are needed to optimize spending. For example, a high level of debt relative to equity could indicate financial risk, while a large amount of cash could indicate strong financial standing.

What are the components of a balance sheet?

The three components of the balance sheet are assets, liabilities, and equity. The two major components are assets and liabilities.

1. Assets

Definition

An asset is a resource that is owned or controlled by an individual, company, or organization that has economic value and is expected to provide future benefits.

Types of assets

There are two types of assets based on their duration of cash conversion.

• Current: These are expected to be converted into cash within one year
• Non-current: These are expected to provide economic benefit beyond one year.

There are two types based on their nature.

• Tangible: Assets that can be physically perceived and identified, like buildings, vehicles, etc.
• Intangible: Assets that cannot be physically perceived and identified, like patents, trademarks, etc.

Common assets found on a balance sheet

• Accounts receivable
• Inventory
• Property, plant, and equipment
• Cash and cash equivalents
• Marketable securities
• Deferred tax assets
• Investments in other companies
• Intangible assets, such as patents and trademarks
• Prepaid expenses

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2. Liabilities

Definition

Liabilities are what a company owes to others and represent the obligations and debts that must be repaid in the future.

Types of Liabilities

We can classify liabilities into two types: current and long-term.

• Current liabilities: They are due within one year or before the company’s operating cycle end, whichever comes last. These are typically short-term obligations that must be paid off quickly and may include items such as accounts payable, salaries and wages payable, taxes owed, and short-term loans.
• Long-term liabilities: They are due more than one year in the future. These are typically larger obligations that will take longer to pay off and may include items such as long-term loans, bonds payable, and lease obligations.

Learn more about liabilities here.

Examples of Liabilities found on a balance sheet

• Long-term debt
• Deferred revenue
• Unearned revenue
• Accounts payable
• Notes payable
• Accrued expenses

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3. Equity

Definition

Equity is the portion of a company’s value that is owned by its shareholders and reflects the value of the company’s assets that are not subject to any liabilities or obligations to others.

Types of Equity

In accounting, equity is typically listed on a balance statement and is composed of two main components: common stock and retained earnings.

• Common stock – It presents the initial investment made by shareholders in exchange for ownership in the company.
• Retained earnings – They give you the portion of a company’s earnings that have not been paid out as dividends but have instead been reinvested in the business or held as reserves.

Examples of common equity found on a balance sheet

• Common stock
• Preferred stock
• Additional paid-in capital
• Retained earnings
• Accumulated other comprehensive income
• Treasury stock

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Balance sheet format

This is the basic sample of a balance sheet format. This may differ based on the company’s needs and accounting standards.

Balance sheet formula

The balance sheet formula states that a company’s assets must be equal to the sum of its liabilities and equity. This formula is the basis for creating a balance sheet, which provides a snapshot of a company’s financial position at a specific point in time.

This is the balance sheet formula:

Assets = Liabilities + Equity

According to this formula, you can see that the total asset value of a company must always remain equal to the combined value of its liabilities and equity.

How to make a balance sheet?

Balance sheet example

Best practice approach for balance sheet

It is vital that you follow balance sheet best practices to avoid inaccuracies, data contamination, and inconsistencies. After all, it is the document that is going to help your finance team make future financial decisions.

Here are the best practices that can help you create a perfect balance statement–

1. Accuracy is key: It’s important to ensure that all information is accurate and up-to-date. This means checking all figures and calculations and verifying that the information included is correct.
2. Consistency is crucial: Consistency will help you ensure that the information is comparable across different periods, which is important for tracking changes in a company’s financial position over time.
3. Separate accounts: Keep separate accounts for each type of asset and liability, such as cash, accounts receivable, and accounts payable. This will help maintain a clear record of where money is coming from and going.
4. Organize well: Make sure that the sheet is organized in a clear and concise manner.
5. Regular review and analysis: Regularly review and analyze the sheet to ensure that it accurately reflects the financial position of the company. This will help identify any potential issues or areas for improvement and can inform decision-making for the company’s financial future.

Quick Read: Cash Accounting – What It Is and Why You Need It

How can Happay help you manage your expenses?

Happay is an end-to-end expense management solution that integrates with your existing systems to give you complete control of employee spending. It gives you a 360-degree overview of your company’s major recurring spending and also supplements your financial decision-making with crucial information.

Quick Read: 10 Best Expense Management Software and Tools

Conclusion

A balance sheet is a financial statement that gives you a summary of a company’s assets, liabilities, and equity at any time. It gives a concise overview of the financial health of a company and aids in decision-making regarding investment or lending.A lot of people use this financial statement including creditors, investors, accountants, company leaders, etc. Overall, it is a valuable instrument for anyone seeking to comprehend a company’s financial position.

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