Balance sheet definition

Balance Sheet Definition and Components

Balance Sheet Definition –  “A document summarizing a company’s financial position – its assets, liabilities and owners’ equity – at a specific point in time”. According to the fundamental equation of the balance sheet, a company’s assets equal its liabilities plus owners’ equity.

In simple words, Assets  = Liabilities + Owner’s Equity

The main purpose of it is to assess the financial position of the company. Firm’s prepares it every quarter, half yearly or on annual basis. This is not a tool to compare the accounts of two firms or organizations. Rather it shows the total assets the company owns and the liabilities that it owes plus owner’s equity.

A standard Balance Sheet consist of two main heads Liabilities and Assets. Assets are the economic resources of the company that provides benefits in the future. Whereas liabilities are the short term or long term debts that company owes to the outsiders. Liabilities side of Balance Sheet also consists of owner’s equity or shareholder’s equity.

Components of a Balance Sheet

There are four elements of balance sheet – Assets, Liabilities, Reserve and Surplus and Shareholder’s equity.

Assets –

In this higher liquid item or asset record first. It means the assets which is convertible into cash within 1 year gets the first position. Assets in the Balance Sheet are divided into Fixed Assets and Current Assets. Below is the sequence of recording assets is given –

Current Assets Examples

  1. Cash and Cash Equivalents – This consists of normal currency, T- Bills and certificate of deposits.
  2. Marketable securities – These are the securities which are easily convertible into cash within period of 90 days.
  3. Account Receivables and debtors – money that the outsider owes to the company. These outsider are customers or debtors.
  4. Inventory – this consists of finished goods that are ready for sale.
  5. Prepaid Expenses – refers to the payment made in advance by company such as advance tax, insurance, etc.

Long term Assets

  1. Long term Investments – These are the securities or investments that cannot be convertible into cash within one year.
  2. Fixed Assets – Such as Land, Building, Machinery, Livestock, equipment, etc
  3. Intangible assets – Such as Goodwill, trademarks, patents, copyrights etc.

Liabilities –

The amount that an organization owes to outsiders. These are of two types – Long term liabilities and current liabilities.

Current Liabilities Examples

  1. Interest payable
  2. Accounts payable
  3. Outstanding expenses
  4. Overdraft

Long term Liabilities includes the following:

  1. Long term debts – these includes the interest or principal due on the bonds.
  2. Deferred tax liability

Shareholder’s Equity –

It is the money invested by the owner of the company that is shareholders. Sometimes, it is also known as Net assets. As it is calculated as total assets minus total liabilities.

It consists of the following items :

  1. Paid up capital
  2. Retained Earnings
  3. Treasury Stock

Reserve and Surplus – 

Company keeps reserves and surplus in order to meet the crisis. For example – General Reserve.

How Balance Sheet Works ?

To understand Balance Sheet definition more clearly, let’s discuss an example. Say ABC company take a loan of 5,00,000 for 7 years from a bank. This means that bank will give this amount to the firm. Now what happens? This amount adds to cash in the assets side, thereby increasing the assets side balance. Loan is a liability for the firm so the amount adds in the long term debt under head liability. So, this is how balance sheet works.