A balance sheet is a summarized financial statement of accounting data that is prepared at the end of the accounting process. It is a medium through which accounting information can be communicated with internal and external users.
It is a statement of assets and liabilities that shows the financial position of an enterprise at a specified point of time. That is why the balance sheet is also known as Position Statement.
Some of the fundamental characteristics of the balance sheet are:
- It demonstrates the financial position of an enterprise.
- Balance sheet works on an accounting equation that describes the assets and liabilities. The equation that it follows is Assets= liabilities + owner’s equity i.e., Shareholder’s Funds.
- The balance sheet is prepared by taking the balances at the yearend of assets, liabilities, and shareholders’ funds.
Form of the Balance Sheet
How It Works
The balance sheet is separated into two sections that work on a single equation which satisfies the condition of balancing each other out. The equation that follows is
Assets= liabilities+ shareholders fund
This implies that the assets that an enterprise owns or used to run the same should be adjusted entirely with its liabilities it has alongside the equity fund that shareholders brought into the organization and its retained earnings.
Assets are the resources that an organization uses to run its business. Liabilities and equities are the two sources that support the assets in the smooth running of a business. On the other hand, shareholders fund or equity or investors value is the measure of cash that is brought by the investors initially in the organization along with the retained earnings or profit. It speaks to a source of funding to the enterprise.
Content of Balance Sheet
The balance sheet is prescribed in schedule VI of the Companies Act, 1956, which is broadly classified into two parts. The first one is equity and liabilities, and the second is assets.
Equity and Liabilities
Investment is the liability of an enterprise towards its shareholders, and thus, it is termed as ‘Shareholders funds.’ It majorly consists of share capital, reserves, and surplus and lastly the money received against share warrants.
Share capital refers to the shares issued by the company for the subscription means and subscription received against issued share capital. It includes both equity share capital and preference share capital. According to the schedule VI of Companies act 1956, balance sheet shall disclose authorized capital, issued capital, and subscribed capital in it.
Reserves and Surplus
Reserve means the amount that is set aside by the company out of profits and surpluses by considering the future uncertainties that can be occurring in the future. Reserves are especially created to meet the future prospective losses or to strengthen the financial position of the enterprise.
Money Received Against Share Warrants
Share warrants are the financial instrument that gives the holder full right to acquire the equity shares. Share warrants will be converted into equity shares at a rate previously determined on a specific date. It has to be converted in equity share in future, therefore is including under shareholders’ fund.
Liabilities are the obligation of the company towards the external people of the company i.e., responsibilities towards outsiders. It consists of current debts and non-current liabilities.
Current liabilities are the liabilities which is due to be settled within 12 months after the date of the balance sheet. According to schedule VI, current liabilities are classified into short term borrowings (which are due for payment within 12 months from the date of balance sheet), trade payables ( amount payable against purchase of goods and services in the regular running of an enterprise),
other current liabilities ( includes current maturities of long term debt, interest accrued but not due on borrowings, income received in advance, unpaid dividends and other payables), short term provisions ( amount set aside for the future liability or mishappening such as provision for doubtful debts, provision for employees benefits, provision for expenses, provision for tax, other provisions etc.)
Non-current liabilities are those who cannot be settled within 12 months period of time calculated from the date of the balance sheet. It includes long term borrowings (amount taken as loan by the company that may be through issue of debentures, borrowing from banks and private money lenders or public deposits), deferred tax liabilities, other long-term liabilities ( includes trade payables such as sundry creditors and bills payable) and long term provisions ( provisions against which liability can occur after 12 months from the date of the balance sheet.
Also, in the middle of shareholders funds and liabilities, share applications money pending allotment is also present in the prescribed form.
Assets are broadly divided into current assets and non-current assets
Current assets are the resources or investments which can be converted into cash within a short period, say within 12 months from the date of purchase if investment. Current assets are further classified into six heads. It includes current investments ( such as investment in equity market, in preference shares in government securities, debentures or bonds or in other investments), inventories ( raw materials, work-in-progress, finished goods, stock-in-trade, loose tools etc), trade receivables (amounts receivable for sale of products and services while running the business on regular days), cash and cash equivalents ( includes balance with bank, cash in hand, cheques etc.)
Non-current assets are opposite to current assets. These investments cannot be converted into cash within short of the period i.e., 12 months from the date of purchase. Non-current assets are classified into five major headings. It includes fixed assets ( assets which company owns for an extended period of time without intending to sell it such as land, building, machinery etc.), non-current investments ( it includes trade investments that the company makes in shares or debentures of other company and other investments), deferred tax assets, long term loans and advances ( loans and advances that the company expects to receive back in the form of assets after 12 months from the date of balance sheet) and other non-current assets (includes long-term trade receivables and other assets)
Kinds of Balance Sheet
There are two ways in which balance sheet can be prepared i.e., Horizontal balance sheet and vertical balance sheet.
Horizontal balance sheet
In this type of balance sheet, items are divided into two columns left and right. Items of asset side are placed in the left side, and details of liabilities team are placed on the next column.
Vertical balance sheetThis is the most common method that most of the companies follow to create a balance sheet. In the vertical balance sheet, all the items are lined down on the left side of the page. The vertical type is most comfortable to create and use.
Objectives of Balance Sheet
The main goals of preparing the balance sheet are:
- It provides critical financial information on economic resources and liabilities of the enterprise.
- It shows the implications of the operating profit on the financial position of an enterprise.
- It provides reliable and necessary information to interested parties.
Analysis of Balance Sheet With Ratio
Ratios are another way to analyze the balance sheet to gain knowledge of the financial position of an enterprise. The debt-to-equity ratio is one such ratio that gives a decent sense of the company’s financial situation alongside its operational proficiency.
The primary and essential ratios that are used for analyzing balance sheet are financial strength ratio and activity ratio.