If you’re studying a business-related course, you will have come across the 3 financial statements. As the fundamental statements that provide a snapshot of any company’s finances, it’s important to be across all of these. This blog provides an overview to one such statement: the balance sheet.
The balance sheet is also known as the statement of financial position. As the name suggests, it provides a snapshot of a company’s financial position at the end of the reporting period. On the left hand side we have:
Assets: Resources for a firm which provide it with an economic benefit, arising from past transactions. These can be further broken down into:
Current assets: Resources held for the short-term (usually will be consumed within the next 12 months). This commonly includes resources such as cash, inventory, and accounts receivables (expected payments from customers).
Non-current assets: Resources held for long-term operations. This commonly includes items such as equipment and machinery.
On the right hand side we have:
Liabilities: Claims to a firm’s cash flows from parties external to the firm, arising from past transactions. This includes:
Current liabilities: Amounts the company needs to pay in the short-term (usually within the next 12 months). These are commonly held for daily trading purposes, such as accounts payable (expected payments to suppliers) and bank overdrafts.
Non-current liabilities: Longer-term debts and loans not due for payment in the short-term. These are often incurred to fund large-scale business operations or capital raising initiatives.
Owners’ equity: The internal claim of the owner(s) against the business. Originating from the amount the founders first invested into the business, it now represents the residual interest the owners have in the assets of the business, after all liabilities are paid.
Next, let’s introduce an important concept: the fundamental accounting equation. It goes as follows:
Assets = Liabilities + Owner’s Equity
This equation outlines how changes in wealth due to a business’ trading activities will lead to changes in the owners’ stake in the business. If the two sides of the equation balance out for the company (hence the name “balance sheet”!), the company’s finances are in order. In effect, this equation ensures that the company’s total debits equal its total credits.
Overall, the balance sheet is a useful tool for giving an overview of how a business is financed and how these finances are deployed. It provides insight into the liquidity and solvency of the business, and is often the basis for calculating many financial ratios that calculate the company’s financial health.
Disclaimer: The intent of this blog is to provide careers advice, not financial advice. It does not take into account individual circumstances. For financial advice, please see a financial adviser.
