In this article, you will get to know all the details about balance sheet and how it is prepared. If you are an accounting student, balance sheet will be an important part of your academic life. Mastering how to do proper balance sheet is not easy, but with practice you will learn the tips and tricks.
Balance Sheet is a financial statement that determines the financial position of the firm. It displays the list of assets, liabilities and the equity under the owner of the firm at a given time period. The reason why people prepare balance sheet is because they want to know the financial position of their business in that time duration. There is no specific date for preparing a balance sheet; it can be prepared at any given time. But, people usually prepare the balance sheet at the end of the fiscal year or the accounting period.
It is one of the most important financial statements that is prepared in the accounting period and helps in determining the standing of a firm in the market. It is basically a snapshot of what your business looked like in that year and how it performed. It is quite different from the income statement as balance sheet does not keep an account of the day to day activities. This can be the reason why people do not rely much on balance sheet as it is prone to mistakes and errors. Balance sheet shows how the resources of the firm’s assets are controlled by the liabilities or the shareholders equity.
How the Balance Sheet is Structured with Examples?
The balance sheet can be broadly divided into three categories- the first being the assets section, second is for liabilities and last column for owners’ equity. Different companies will have different balance sheets with a few minor differences here and there. However, there are a few things that will always come in a balance sheet. Given below is a list of items that you will always find under current assets, liabilities and equity sections.
All the resources of a business are listed in the assets section. Assets that have similar traits are all listed in this section and are grouped together. The broad categories that assets are divided into are current assets and non-current assets. What are currents assets? These are cash receipts and assets that are liquid, that is, the assets that can be converted into cash. For example-;
- Cash equivalents
- Prepaid expenses
- Account receivables
- Short-term payments, etc.
Liability is the obligation of a firm to other parties and business owners. The broad categories under liabilities are current liabilities and long-term liabilities. Current liabilities are payments that a firm has to meet within a year, either by selling off the current asset or by provision of goods and services. And the liabilities that are not current are all considered to be long-term liabilities. For example-
- Current liabilities
- Accrued expenses
- Accounts payable
- Lines of credit
- Unearned revenue
- Current portion of long-term debt
Examples of long-term liabilities:
- Mortgage payable
- Notes payable
- Loans payable
- Long-term liabilities
Owner’s equity is the obligation that a company has towards its owners. The term “owner’s equity” is usually used when preparing balance sheet for a joint venture or sole proprietorship business. In other companies the term “owner’s equity” is replaced with “stockholders equity.” Always remember to keep liabilities prior to equity section.
How is the Balance Sheet Used in Financial Modelling?
As already mentioned, balance sheet is used to determine the financial position of the firm. In order to calculate different ratios, an analyst can take help from a balance sheet which will show the performance of the company in the previous accounting period. It will display how liquid or solvent a business is and its efficiency.
The changes that take place in the balance sheet are also used in calculating cash flow in the cash flow statement. Say, for example, a positive change in the balance sheet will indicate the value of depreciation through which you can calculate the cash flow.
- Balance Sheet Examples?
Given below is an example of Amazon’s balance sheet of the year 2017 taken from a case study of the CFI’s Amazon course.
- What is the Importance of the Balance Sheet?
Balance sheet is one of the most important financial statements, and that too for a reason. given below are some of its benefits:
- Liquidity- When you compare the current asset of a company to its current liabilities, you will get a clear picture of the liquidity of the firm. In order to fulfil the short-term obligations, a company’s current assets must be greater than its liabilities. Example of liquidity financial metric- current ratio and quick ratio.
- Leverage- Looking at the finances of a company one can easily know how much leverage a company has. This will indicate the financial risks a company is taking.
- Efficiency- When using the income statement, one can easily asses the efficiency of a company and how it has been using its assets. For example, when you ivied revenue with fixed assets, you will get Asset Turnover ratio which will help in indicating how efficiently the company has turned its assets into revenue.
- Rates of return- Balance sheet can be used to analyse the efficiency of a company and how well it is doing in terms of generating returns.
Download Free Balance Sheet Templates?
If you want to save yourself some time then you instead of making the balance sheet, you can just download a template. Number of websites on the internet provides free templates that can be easily downloaded. All you have to do is provide your name and email to them.
Now that you know what a balance sheet is and the things that go into it, you can start with practicing a few examples with solutions. Having solutions will clarify the doubts that you come across and boost your confidence.