Balance Sheets Made Simple
This is part 3 of the financial statement series. The individual parts are:
Knowing How The Statement Of Retained Earings Works
Knowing How The Statement Of Retained Earings Works
How do you make reading a balance sheet nice and simple to understand? That is what I’ll be doing here. The balance sheet is another part of the financial statement which is wonderful for a business owner or investor because it allows them to very quickly assess the financial health of the company, which helps them to make their buying or investment decision. It can be very confusing but it’s really quite simple once you understand it. Let’s get stuck in!
What is a balance sheet?
The balance sheet simply shows you how a company is doing in terms of its finances at a particular point in time. It shows things such as how much debt the business is currently in, how much money the business has, the value of what the business owns etc.
The formula for a balance sheet is the following:-
Assets = Liabilities + Shareholders Equity
What on earth does that mean and how does it work? Read on
ASSETS
The assets of a company are the things they own which have value.
Current Assets – Anything that can be converted into cash within 1 year or less. You can list things like cash in the bank, money that should come in from customers [Accounts receivable], Products and materials in a company’s possession [Inventory] etc
Fixed Assets – Anything of value that will typically take more than 1 year to convert to cash. These include things such as the building the business is in, the computer equipment, any vehicles the company has, any furniture etc!
Long term assets – These are things which are more difficult to convert to cash such as goodwill, patents, stocks/bonds etc
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| An Example Of A Balance Sheet |
LIABILIITIES
The liabilities of a company refer to anything the company owes to others. Most of the time, these are separated into 2 parts also
Current liabilities – These are things that are expected to be paid within a year or less. They include salaries due to be paid to employees [payroll], money owed to others [accounts payable],
Long Term liabilities – These are things that are due to be paid after a year or more. An example would be a 5 year loan a business may have borrowed.
SHAREHOLDERS EQUITY
This is the amount of money the business owners/investors have put into the company plus OR minus the companies earnings or losses since during that period.
How Does A Balance Sheet Balance?
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Why and how should all this stuff balance?? All of the figures must go in the right place so that when you add the liabilities and shareholders equity, it represents the asset figure.
Say I bought a £1000 bicycle. I borrowed £500 for it and used £500 of my own money for it. I am the owner and the people I borrowed money from are the investors. It would look like this
Assets – £1000
Liabilities – £500 [I owe £500 to my investors]
Shareholders Equity – £500 [This is the amount I invested in the bicycle]
The reason why a balance sheet must balance is that any transaction that takes place should register in two different places. This ensures that things remain consistent. If I were to sell the bike the asset account would decrease by £100 but the accounts receivable side [money coming into the business] would increase by 100. This is the reason why if the accounts don’t appear to balance then it is because an error has been made somewhere on the balance sheet.
Remember that the shareholders equity is the amount of money owners/investors have put into the company plus the earnings or losses during that time. With that in mind, it becomes too easy to understand how it is supposed to balance.
Check out information about how to read the Income Statement and the Cashflow Statement
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