Balance sheet is a financial statement that shows an entity’s financial position at a particular point in time. You can see it as a snapshot of a company’s financial position at a particular point in time. Balance sheet is a part of the complete set of financial statements. A complete set of financial statements usually has the following statements or components:
- Balance sheet
- Income statement
- Statement of comprehensive income
- Statement of changes in shareholders’ equity
- Statement of cash flows
In the next chapters of this section, we’ll go through all of these financial statements.
Balance sheet explained
Balance sheet reports the amounts of assets, liabilities, and equity of an entity at any particular point in time. In other words, it represents:
- What an entity owns (assets)
- What an entity owes (liabilities)
- What is the net book value of the entity, i.e., the difference of assets and liabilities (equity)
At all times, a balance sheet holds true to the accounting equation we learnt in basics of accounting. It means that total assets will always be equal to the sum of total liabilities and shareholders’ equity.
Assets = Equity + Liabilities
Let’s briefly go through each type of account which is reported in the balance sheet.
Assets of an entity are the resources that are owned and controlled by the entity. Things that are beneficial to the entity and which will be used to generate economic benefits for the entity in future. Let’s take a look at some examples of assets to make it clearer. First asset that comes in mind is CASH, Yes! That is an asset. Factory building, machinery, office equipment, computers, vehicles, stock of materials and finished goods etc. are all examples of assets. But wait! we might be missing something. What about the sales that an entity has made on credit? Such trade receivables are also assets of the entity. Similarly, prepayments are also a type of asset which is not that obvious, for example, prepaid insurance, advance rent, advances to suppliers etc.
Liabilities are the amounts that an entity owes to other parties. These financial obligations include both legal and constructive obligations. Legal obligations are the ones which are enforceable by law, such as those arising from any contractual arrangements or statutory obligations such as tax payable etc. Constructive obligation is an obligation which is created by an entity’s pattern of past practices, published policies or statements that has created a valid expectation in the minds of third parties that the entity will discharge certain responsibilities. For example, annual bonus has not been agreed contractually with the staff, but an entity regularly pays annual bonus to its staff. Other common examples of liabilities include payable to suppliers, salaries payable, utility bills payable, loan payable etc.
Equity is the difference of assets and liabilities of an entity at any particular point in time, which is why it is also referred to as “Net Assets” or “Book Value” of an entity. It comprises of the amounts invested by the owners and accumulated profits or losses of the entity. For sole proprietorship, it is called owner’s equity whereas for corporations where there are more than one owners, it is called shareholders’ equity.
We have briefly explained all three components of balance sheet. Let’s take a look at how the balance sheet looks like. Following is a sample balance sheet of XYZ Company as at 31 December 2020.