The first step to understand what is a balance sheet is to start from the very basics of the accounting – accounting equation, which is basically the same as balance sheet equation.
Accounting equation states, that:
The underlying meaning of this equation is that any assets, which are owned by the business (left side of the equation) are being financed either by liabilities (borrowed funds, which at some point of time will have to be returned back to the lenders) and owners’ equity (financial means owned by the owners of the business, i.e. funds invested into the business in exchange for the ownership rights).
Balance sheet is one of the four main financial statements, which are being prepared to reflect and report business operations for a particular period of time. These financial statements are the following:
- Balance Sheet
- Income Statement
- Cash Flows Statement
- Statement of owners’ equity
Balance sheet is a reflection of the accounting equation and presents data about the assets being owned by the business and financing sources of those assets (liabilities and owners’ equity) as of particular date. Balance sheet provides information about capital structure of the business, i.e. indication, which part of the assets is being financed by borrowed means, and which is being finance by funds belonging to the owners of the business.
Various financial ratios can be used based on the balance sheet data in order to analyze business performance, liquidity, solvency and other areas of business operations.
Users of the balance sheet data must remember that this financial statement has certain limitations, i.e. all the data presented is based on the historic cost, which does not properly reflect fair values of the assets and liabilities. Also data in the balance sheet is subject to the accounting principles and assumptions, which should be taken into account while the data is being analyzed. Also not all the data is presented in the balance sheet and the reason for this is the fact that it is simply not possible to reliably account for such items, like reputation, skills, client potfolio and similar items.
Balance sheet will always include the following items:
Assets – this category includes Properties (can be material, immaterial, monetary) owned by the entity are called assets any physical thing (tangible) or right (intangible) that has a monetary value
Liabilities – this category Debts owned to outsiders, i.e. creditors
Owners’ Equity – this category includes Amounts invested in a business by owners, special kind of liability residual claim against assets of business after total liabilities are deducted