Financial statements: what is a balance sheet?

Financial statements are described as the end result of transactions between a specific entity and other companies and individuals. Transactions include sales, purchases, and general cash flows. There are several types of financial statements, including balance sheet, income statement, cash flow statement, and statement of changes in equity. This article will examine one of the most important financial statements, the balance sheet.

Balance sheet

The balance sheet is a statement that describes the financial position of an entity at a given time, usually at the end of an accounting period. Represents the assets, liabilities and capital of the owners of the organization.

The balance equation is followed,

Assets = Liabilities + Owner’s equity.

The two sides of the equation balance, hence the state is called balance.

Assets are the economic benefits that will be acquired and controlled by an organization as a result of past transactions. Assets are tangible; They include cash, accounts receivable, inventory, and equipment. Assets can be divided into current and long-term. Current assets, such as cash and accounts receivable, are assets that are or can be transformed into cash or benefit the company within a year. Long-term assets, on the other hand, which may include land, inventory, and equipment, pay off and will benefit the business over an extended period of time. Accumulated depreciation is used on balance sheets to explain how long-term cost of assets is “spent” during the process of running a business. The cost is distributed over the life of the asset. For example, let’s say a piece of machinery costs $ 50,000 and the useful life of the machine is 20 years, therefore, in the first year, the accumulated depreciation of the equipment is $ 2,500.

Liabilities can be explained simply as amounts owed to other organizations, such as the transfer of assets or the services that need to be provided. Liabilities are also made up of current and long-term. Current liabilities are those that will be paid within a year, these include accounts payable, notes payable, current long-term debt maturities and payroll taxes. Long-term debt is debt that is paid off over a long period of time.

The owner’s equity, also called net assets, is the property right that the owners of the organization have after subtracting the liabilities. Some examples of owner’s equity include common stock, additional paid-in capital, and retained earnings. Common shares are issued as an investment in the business. For example, in corporations, shareholders are ultimately the owners, claiming all assets after liabilities and preference share claims are satisfied. The additional paid-in capital is defined as the excess amount paid by the investor over the declared value of the shares sold. Finally, retained earnings are net income that is not distributed as dividends to owners or an organization.

So what is the purpose of a balance sheet? First, business owners use balance sheets to analyze the strength and capabilities of their business. For example, is the business ready to expand? However, should the company take immediate steps to strengthen cash reserves? In addition, balance sheets describe trends, especially in the area of ​​accounts receivable and payable. For example, is debt on accounts payable being paid and debt on accounts receivable received in a reasonable amount of time? Finally, banks, investors and suppliers examine the balance sheets to determine the amount of credit they will grant to the entity.