A balance sheet is a very important financial tool, for any business. It is a financial statement that reports a company’s assets, liabilities and shareholder’s equity at a specific point in time and provides a basis for computing rates of return and evaluating its capital structure. It is also known as a statement of financial position or statement of financial condition. It is a summary of the financial balances of an individual or organisation. Whether it be a sole proprietorship, a business partnership, a corporation, private limited company or other organisations such as government or non profit entity. It provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders. The balance sheet, along with other financial statements such as the income statement and statement of cash flow, is used to conduct fundamental analysis or calculate financial ratios.
CONTENTS OF A BALANCE SHEET :
A balance sheet is a freeze frame. Its purpose is to depict the value of various components of a business, at a moment, in time. Most of the contents of a business balance sheet are classified under one of the three categories – assets, liabilities and owner equity. Balance sheets are typically presented in two different forms. In the report form, asset accounts are listed first, with the liability and owner’s equity accounts listed in sequential order directly below the assets. In the account form, the balance sheet is organised in a horizontal manner, with the asset accounts listed on the right side. The main categories of assets are equally listed first and typically in order of liquidity. Then the liabilities are listed on the liability side. The difference between the assets and liabilities is known equity or the net assets or the net worth or capital of the company. In fact, the term balance sheet originated from this latter form as the sum total of both the sides must be the same – in other words, they should balance.
ADVANTAGES OF A BALANCE SHEET :
The balance sheet is used internally to help manage the company and externally to report the company’s financial condition. There are several advantages of preparing a balance sheet, some of which include –
• Keeping things in balance – The balance sheet equation reflects that a company’s assets equal its liabilities plus its stockholders’ equity. Since this equation must always hold good, any deviation from this indicates a failure of the company’s accounting system.
• Calculating and analysing ratios – Managers, investors, lenders and regulators take the measure of a company by calculating financial ratios, after using information from the balance sheet. This is often done in conjunction with other reports such as the income statement. There are several balance sheet ratios that help detect important financial trends.
• Obtaining credit and capital – Before lending money or extending line of credit to an established or new business, the lending institution will likely require a balance sheet to help assess a business’ credit worthiness and financial state.
DISADVANTAGES OF A BALANCE SHEET :
• Misstated long term assets – The balance sheet records the value of long-term assets at the price paid for them, known as historical or book value. One of the limitations of a balance sheet is that it ignores the current value of these assets. Book values can substantially understate long-term assets, distorting the wealth of the company.
• Missing assets – The assets which are acquired by transactions, only those are reported on the balance sheet. Therefore it omits some very valuable assets that are not transaction-oriented and can’t be expressed in monetary term. For example, a company might have a highly valuable group of technical experts who are nearly irreplaceable and yet that would not be reported on the balance sheet.