What is a balance sheet?
In accounting, the balance sheet definition refers to the financial statement that reports the financial position of a company, detailing its assets, liabilities and shareholders’ equity at a particular point in time.
Simply put, a balance sheet meaning can be compared to a school report: it gives investors an overview of a company’s performance at a specific moment in time, illustrating the business' net worth.
Along with the income statement and statement of cash flows, a balance sheet is one of the three core financial statements prepared by a company’s management and used to evaluate a business. Together, these help to conduct fundamental analysis or calculate financial ratios, allowing investors to get a sense of how healthy the company is.
Where have you heard about balance sheets?
The balance sheet tends to be published at the end of a fixed trading period, such as a financial quarter. Since balance sheets gauge the performance of a company, the term often hits the headlines when some large business is having a tough time.
What you need to know about balance sheets…
Generally, there are two forms of balance sheet in financial accounting. These are the report form and the account form. The main difference lies in the way the content is positioned on the list. The account format presents the asset accounts on the left side and liabilities and equity accounts on the right side. The report format, on the other hand, presents all the accounts vertically. Although both types of balance sheet are acceptable, the report form is used more frequently.
Typically, individuals and smaller businesses have simple balance sheets, while larger businesses tend to have more complex financial statements, presenting them in the organisation's quarterly or annual reports. Besides, large companies may sometimes prepare separate balance sheets for different segments of their businesses.
The balance sheet is based on a simple formula: assets = liabilities + equity. The total assets should be equal to the sum of total liabilities and total shareholders’ equity.
Assets are things of value, which a company controls but not necessarily owns. They can be divided into two types: current and long term assets. As well as cash, securities and inventory, assets might also include debts you expect to recover.
Liabilities, on the other hand, are the debts or obligations of a company. These can also be categorised as current or long term. Liabilities would typically include things like taxes, rent, unpaid debts to suppliers, interest on bonds and salaries to employees.
If you subtract liabilities from assets, you will be left with the shareholders’ equity – the money in the business that is owned outright.
Comparing previous and current balance sheets gives an idea of a company’s performance over time, while comparing the balance sheets of different businesses can help investors decide what to invest their money in.
Those interested in the balance sheets include bankers, creditors, government agencies, current and potential investors, company management, suppliers, competitors, customers and even labour unions.
If you want to be successful as an investor, it is crucial to know how to read a balance sheet. However, to obtain a comprehensive picture of the company’s overall financial situation and make the right investment decisions, the balance sheet should be studied together with the other financial statements, including income statement, statement of comprehensive income, statement of cash flows and the statement of changes in stockholders' equity.
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