Introduction to the Balance Sheet
The basic balance sheet is one of the main accounting statements. The statement shows a snapshot of the assets, liabilities and equity of the business at a specific point in time, usually at the end of an accounting period.
The balance sheet is sometimes referred to as the ‘Statement of Financial Position’.
The balance sheet does not form part of double entry it is simply a list of balances at a specific date arranged as as assets, liabilities or equity.
Balance Sheet Layout
The layout of a simple statement of financial position 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. The example below shows a typical and useful format for management purposes.
|Total liabilities and equity||800,000|
Notice how the statement is at a specific date (in this case 31 December 2019), 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. In this example the balance sheet asset information is presented in liquidity order.
Basic Balance Sheet Example
As an example, the Annual Report for Apple below shows a typical basic statement of financial position format for a listed company.
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 Statement of Financial Position
Most businesses tend to concentrate on the income statement and fail to get to grips with the statement of financial position.
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).
- Suppliers use the statement of financial position to identify the net assets and cash position of the business to decide whether to supply on credit terms.
- Bank managers utilise the statement, 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.
- Investors use the balance sheet 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 statement of 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.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.