What Does the Term “Balance Sheets” Mean in Accounting
A balance sheet is one of the most important financial statements that a business owner or business tax accountant has to know about.
The assets and liabilities of a company are shown on a balance sheet. It summarises a company’s financial health, demonstrating how it is supported and what it has done with that funding; it is for this reason that a balance sheet is now referred to as a ‘Statement of Financial Position’ in accounting terms.
What Does a Balance Sheet Contain?
A balance sheet shows your company’s assets, liabilities, and shareholders equity at a specific point in time. The accounts described on your chart of accounts correspond to the items presented on the balance sheet. The following are the components of a balance sheet:Assets The balance sheet’s assets column details what your company possesses in terms of value that may be converted into cash. Your assets will be listed in order of liquidity on your balance sheet, which means they will be listed in order of how readily they may be converted to cash. On your balance sheet, you have two basic categories of assets:
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- Current Assets: Current assets can be converted into cash in as little as a year. On the balance sheet, current assets are further split down into four accounts:
- Your most liquid assets are cash and cash equivalents. Currency, cheques, and money in your company’s checking and savings accounts are among them.
- Securities that can be traded: Investments that can be sold in a year or less
- Receivables (accounts receivable): Money owed to you by your clients for services rendered that will be reimbursed in the near future
- Inventory refers to both finished goods and raw resources in a business that sells goods.
- Expenses paid in advance: Things of value that you’ve already paid for, such as your office rent or insurance.
- Long-Term Assets: Long-term assets are not convertible to cash in a year’s time. They can be subdivided further into:
- Property, buildings, machinery, and equipment such as computers are examples of fixed assets.
- Long-term investments: Investments that aren’t able to be sold in a year
- Intangible assets are assets that are not physical. Assets that aren’t actual objects are referred to as intangible assets. Copyrights, franchise agreements, and patents are among them.
The liabilities portion of a balance sheet is the next section to look at. Your obligations are the amounts of money you owe to others, such as recurrent costs, loan repayments, and other types of debt. Current and long-term obligations are the two types of liabilities.
Rent, utilities, taxes, current payments toward long-term obligations, interest payments, and salary are all examples of current liabilities.
Long-term debts, deferred income taxes, and pension fund liabilities are all examples of long-term liabilities.
EQUITY OF SHAREHOLDERS
Shareholders equity refers to:
- The quantity of money made by a company.
- The amount of money invested in the company by its owners (or shareholders), as well as any capital provided.
In other terms, your net assets represent your shareholders equity. This formula is used to compute it on your balance sheet:
Stakeholders Equity = Total Assets – Total Liabilities
How to Balance a Balance Sheet
Your balance sheet, of course, must always be balanced. There are two sections to a balance sheet. The assets of your company are shown on one side, while the liabilities and shareholders equity are represented on the other.
The combined sum of your liabilities and equity must equal the total worth of your assets. Your paper is said to be in balance if this is the case. The underlying formula of balance sheets exemplifies this concept:
Assets = Liabilities + Shareholder Equity
What Is a Balance Sheet and How Do I Analyze It?
Seeing the data on a balance sheet is only the beginning. To get the most out of a balance sheet, you’ll need to know how to examine it.
Financial ratio analysis is the most effective method for analysing a balance sheet. You’ll apply algorithms to determine the company’s financial health via financial ratio analysis. You’ll also figure out how effective it is in terms of operations.
You can use one of two types of ratios:
- Financial strength ratios are indicators of a company’s ability to satisfy its debt obligations. Debt-to-equity and working capital ratios are two examples.
- Current account and operational cycle expenses are the focus of activity ratios. Receivables, payables, and inventory are all examples of this.
Accountants can use any of the ratios listed above to analyse the data on balance sheets. An accountant can use this information to do a more in-depth analysis of a company’s financial health.
Again, balance sheets are beneficial, but they only go so far. If you want to determine the health of an investment or firm, you’ll need to do a more in-depth investigation.
Who is in charge of balance sheets?
Balance sheets can be prepared by a group of people. Small business proprietors and bookkeepers are examples of these people. Balance sheets can be prepared and reviewed by internal or external accountants.
Are There Any Limitations to Balance Sheets?
Yes. Balance sheets contain a few of disadvantages that investors, analysts, and accountants should be aware of. The financial parameters of the organisation are only shown on balance sheets at a single point in time. As a result, balance sheets aren’t always reliable indicators of future business performance.
In addition, balance sheets are by their very nature stagnant. Accountants may want to use data from the balance sheet and other forms for the finest financial analysis. A cash flow statement or dynamic income statements are examples of these. These might provide a more detailed picture of the company’s financial condition.
There’s one more drawback. Managers may be able to alter balance sheets using accounting systems or depreciation processes. This exposes financial sheets to fraud. Some bosses may tamper with financial statements to make them appear more profitable than they are. As a result, anyone reviewing a balance sheet should carefully study the footnotes to ensure there are no red flags.
FURTHER READING: What Does the Term “Overheads” Mean in Accounting