Introduction to the Balance Sheet
The basic balance sheet is one of the main accounting statements. The basic balance sheet shows a financial snapshot of the business at a specific point in time, usually at the end of an accounting period.
For presentation it can be shown vertically with assets above liabilities and equity, or horizontally with assets on the left and liabilities on the right.
The balance sheet must always balance and satisfy the basic accounting equation:
The balance sheet is sometimes referred to as the ‘Statement of Financial Position’.
Balance Sheet Format
The layout of a balance sheet for a company for annual reporting purposes is legally defined. However, for management account purposes the layout should be in the format most useful for managing the business. A typical and useful format for management is shown in the example below.
|Long term assets||450,000|
|Total liabilities and equity||800,000|
Notice how the balance sheet is at a specific date (in this case 31 December 2016), and satisfies the accounting equation, total assets (800,000) of the business are equal to the liabilities (400,000) plus the equity (400,000) in the business.
Balance Sheet Example
As an example, the Annual Report for Apple shows a typical balance sheet layout.
What the Balance-Sheet does not show
The balance-sheet does not show the market value of the business. For example, the assets, particular the long term assets are normally shown at cost or revaluation at a point in time, they do not show the current market value of those assets.
Items such as intangibles, for example the value of the knowledge and skills of employees, are not reflected in the balance-sheet position.
The Need to Understand the Balance Sheet
Most businesses tend to concentrate on the income statement and fail to get to grips with the balance sheet.
The basic balance-sheet is important for many reasons:
- Management should use the financial statement to help identify whether the need for working capital (inventory plus accounts receivable less accounts payable) is growing, and how that need is being funded (equity, overdraft, loans etc).
- The balance-sheet is used by suppliers to decide on whether credit is given as they identify the net assets and cash position of the business.
- Bank managers utilise the balance-sheet, as they base their lending ratios on certain aspects of it, for example the current ratio = current assets / current liabilities is used to determine liquidity and the risk of non repayment of a debt.
- Balance-sheets are used by investors to decide whether to invest or not and at what price. For example they will look at the debt / equity ratio to determine the level of risk involved
Any number of people could be using your balance-sheet financial position to make decisions about your business. It is important that you have an understanding of what information the balance-sheet position is providing and what that information is telling you.