Definition
Balance sheet along with profit and loss statement not only helps in knowing the financial position of the business but also helps the investors in evaluating and invests accordingly.
We will discuss the important balance sheet terms and discuss the format of preparing balance sheet.
What is a balance sheet?
Balance sheet is the financial standing of the business. It shows what your business owns and what it owes. The balance sheet looks similar to a loan form that includes your personal assets and liabilities.
Balance sheet is the most important financial statement of your business, as it will show a summary of assets, liabilities, and shareholder’s equity at the end of the year.
Why to prepare balance sheet?
Balance sheet is the primary financial statement that helps in evaluating the company’s financial health and also helps in taking most important financial decisions.
Basic balance sheet terms
There are various terms associated with the balance sheet. However, the few common terms are explained below:
Assets:
It is the item owned by the business. In the balance sheet, the assets are bifurcated into current assets and long-term assets or fixed assets.
Current assets:
Current assets are the assets that are sold or turned into cash within one year. Cash is the most liquid asset. Other short-term assets are accounts receivable, prepaid rent, prepaid insurance.
Long-term assets or fixed assets:
These assets are not sold within a year. Long term assets or fixed assets include real estate, machinery, and furniture.
Accounts receivable:
It shows money owed by customers who purchased the goods on credit that was provided by the company.
Current liabilities:
A current liability is a loan due to creditors from the beginning to the end of the period.
Accounts payable:
Accounts payable are short-term loans, owed by the business from purchases made on credit from suppliers.
Taxes payable:
Taxes show the amount of tax accrued but not paid.
Long-term liabilities:
Any debt that is more than a year comes under long-term liabilities. It is similar to current liabilities.
Retained earnings:
Earnings reinvested in the business after deducting the dividends are retained earnings.
Owner’s equity (shareholder’s equity):
Owner’s equity also known as stockholder equity, net worth, paid-in capital is the amount that the owners have invested in the business after deducting the withdrawals.
Order of items on the balance sheet
Is there any particular order to list the items as assets or liabilities in the balance sheet?
If we talk about assets, they are ordered first in terms of liquidity. The most liquid assets are placed at the top.
If we talk about the liabilities, the current liabilities are recorded first followed by the non-current liabilities.
Why does a balance sheet should balance or tally?
The main reason for tallying or balancing the balance sheet is the accounting equation we follow which is:
Assets = Liability + Owner’s equity.
If we subtract the assets minus liability, we will be left over with the money invested by the owners also known as owner’s equity.
Balance sheet example
It is easy to create a company’s balance sheet if you using double entry bookkeeping system. Also, it becomes easier to compare two dates for the accounting balance sheet.
Wrapping up
So, we all have learned about the importance of financial statements and the preparation of income statements and balance sheet. After the completion of balance sheet, the next statement to tackle is the cash flow statement.
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