Balance sheet is the statement of financial position of a company. It depicts the financial position (sound or weak) of a company on a specific date. The basic concept involved in balance sheet is that the assets are equal to outside liabilities and owners’ equity. The resources or asset of an organization are always generated through financing. This financing is provided by two sources which internal or external. Internal sources are owners or shareholders who provide capital through investment and reinvesting the profits earned over the periods. External sources on the other hand provide financing through extended credit usually called creditors and granting loans to the firm. It makes sense that the whole financing must be utilized some where in generating resources or assets for the firm, therefore, the value of the firm’s resources must equate the value of whole financing whether internal or external.
The balance sheet forms an integral part of financial statements and extensively used by many stakeholders to judge the financial strength of the company. It demonstrates that how the financial resources are being utilized to generate resources for the firm and what type of resources the firm actually generated over the period. It further guides in inventing whether the financing has generally been employed in high return assets or it may have been wasted in assets with lower potential.
The items in the balance sheet are segregated into the following:
Assets are resources in which the funds are invested. The main categories of assets are:
[linkunit]The assets with useful life of more than one year and are depreciated over their useful life. Fixed assets are represented on historical costs with accumulated depreciation on the fixed assets on the other side of the balance sheet. Annual depreciation is charged to the income statement as expense against revenue generation for that period. Some times revaluation gains and impairment losses on the fixed assets are also entertained in the books of accounts. The examples of fixed assets include land and buildings, equipment, plant and machinery, and furniture and fixture etc.
The assets with useful life lesser than one year are called current assets. Such assets form part of working capital and result in lower return as compare to fixed assets. Some investment in the current assets is compulsory for a firm such as accounts receivables, inventories, short term securities, and cash and bank balances. However, companies can adopt aggressive or conservative policies with respect to investment in current assets. In aggressive policies little investment is made to strengthen the profitability and with conservative policies usually handsome investment is made in current assets to strengthen the liquidity position of the company.
Intangible assets are unseen assets such as reputation of the company named as goodwill. Goodwill is calculated through recommended valuation methods.
Long Term Investments
There may be some long term investments made by a company. Such investments are shown separately in the assets section of the balance sheet.
Shareholders’ Funds – Owners’ Equity
This is called equity section of the balance sheet where capital funds invested by the owners or shareholders are presented. Along with capital funds the reinvestment of the profits over the periods is also cumulated and shown in this section as addition to the equity. The movement in shareholders’ funds over the years is also required to disclose as per international financial reporting standards.
Long Term Liabilities
External funds provided by banks or other financial institutions as debt for a longer time horizon usually more than one year. Some times companies issue bonds or debentures to arrange finance from the general public. Such bonds or debentures are also presented in this section of the balance sheet.
Claims on the current assets of the company are called current liabilities. Such liabilities have to be settled within a financial year. Main part of current liabilities is creditors extending credit of raw materials to the firm. In addition there may be some accrued expenses such as outstanding salaries or rents etc are also treated as short term claim on business and are presented in current liabilities.
Example of Balance Sheet
As at Jun 30 20XX
Liabilities and Owners’ Equity
Land and Building
Machinery and Equipment
Furniture and Fixture
Cash and Bank Balances
Investment in short term securities
Short term loan
Investment in long term securities
The total of the two sides of balance sheet must equal.
Benefits of Balance Sheet
The benefits associated with the balance sheet are as follows:.
• Through balance shareholders can judge that how their capital is being used by the management. In what type of assets their funds are invested to maximize the return. Shareholders through balance sheet review the financial position of the company and can decide to for further investments or divestments.
• Lenders and creditors can judge the liquidity position of the company and make decisions regarding extension of credits and debts.
• Management can decisively evaluate the financial position and take remedial measures if required. Balance sheet helps management in determining the future financial needs.
• Employees can compare the remunerations with financial position and are in a better position to bargain with management for enhancement in remunerations.
Limitations of Balance Sheet
Balance sheet may not depict actual financial strength or weakness of a company because the figures related to the fixed assets are reported in the balance sheet at historical costs. The real value of those assets may be more or less according to their current conditions. Moreover, there may be some liabilities created through off-balance sheet financing such as operating leases etc.