What is a Balance Sheet?
A financial statement that showcases the net worth of an organization by listing the assets and liabilities of the organization, along with shareholder’s equity for a particular period, usually a year, is what a Balance Sheet means.
Importance and Purpose of Balance Sheet
A Balance Sheet shows the financial position of an organization during a particular time frame
The growth of a company is evaluated by comparing the balance sheet of the previous years.
iii) A Balance Sheet displays what an organization owns and what the organization owes.
With the help of the Balance Sheet, potential shareholders and investors can get an insight into an entity’s liquidity position before buying any shares or before investing.
Balance Sheet helps the shareholders and investors to check whether the company will be able to pay dividends.
Balance Sheet provides information regarding the short-term financial position of a firm. subtracting the current liabilities from the current assets will show results of the networking capital, which is the funds required to meet the regular activities (rent, wages, utility bills, etc.) of a company.
Another feature of a balance sheet is that it acts as a crucial document when applying for credit with a bank or other types of financial institutions.
Shareholder’s equity is a crucial part of a balance sheet, which comprises the common shares, the preference shares, and the retained earnings. The Shareholder’s capital can be calculated by subtracting the liabilities from the assets.
According to the Schedule III of the Companies Act, 2013, certain amendments were given and also laid down the format for the preparation of the profit & loss account and balance sheet, which all companies need to follow.
An example of the new structure :
Equity and liabilities.
I) Shareholder’s Funds
Money received against shares reserved and surplus share capital
II) Share Application Money After Allotment
III) Non-current Liabilities
a)Long-term provisions
b)Long-term borrowings
c)Deferred tax liabilities
IV) Current Liabilities
a)Short-term borrowings
b)Short-term provisions
Assets
I)Non-current assets
a)Fixed assets
b)Other non-current assets
c)Intangible assets
d)Tangible assets
ii) Current Assets.
a) Short-term loans
b)Inventory
c)Current investments
d) Trade receivables
e) Other current assets.
The general balance sheet definition is - a financial statement that showcases the net worth of an organization by listing its assets and liabilities along with shareholder’s equity for a particular period, usually a year.
The balance sheet is one of the three primary financial statements prepared by a firm, the other two being –
Profit & loss (P&L) account statement - As the name suggests, the profit & loss account statement shows the net profit or loss of a company during a specific period, which can be a year, quarter, month, etc. It is also known as an income statement.
Cash flow statement - The cash flow statement displays the inflow and outflow of cash within an organization during a specific period.
What is the Purpose or Importance of a Balance Sheet?
Shows the financial position of an organization during a specific time frame.
Growth of a company can be evaluated by comparing the balance sheet of the previous years.
Displays what an organization owns and owes.
Potential shareholders and investors can gain insight into an entity’s liquidity position before buying shares or investing.
Enables shareholders and investors to check whether the company will be able to pay dividends.
Provides additional information regarding the short-term financial position of a firm. For example, subtracting the current liabilities from the current assets will show the net working capital, which is the funds required to meet the regular activities (rent, wages, utility bills, etc.) of a company.
One of the features of a balance sheet is that it acts as a crucial document when applying for credit with a bank or other types of financial institutions.
What is the Balance Sheet Format?
Usually, a balance sheet is created by listing the assets on the left side and liabilities and shareholder’s equity on the right. However, it is also prepared vertically, with the liabilities and shareholder’s equity recorded first and then the assets.
In the case of non-profit organizations, the assets are listed on the right while the liabilities on the left. Additionally, instead of capital, it is a capital fund or general fund. Any surplus or deficit will be added or deducted from this fund before preparing a balance sheet.
Test your skills – Now that you know the format, take a problem from your study material and try to prepare a balance sheet by referring to the structure mentioned below.
What is the Structure of a Balance Sheet?
The balance sheet structure is discussed in details below –
Assets
Assets are what an organization owns. These can be converted into cash in the short-run or long-run. Assets can be of the following two types –
Fixed or Non-current Assets – As the name suggests, these are assets that are “fixed” or immovable. Examples of fixed or non-current assets include land, machinery, equipment, building, goodwill, trademarks, etc. Assets can be classified based on their existence type (tangible or intangible) and usage (operating or non-operating).
Current Assets – These are assets that can be converted into cash (or cash equivalents) within a short period (usually, a year). Examples of current assets include short-term investments, accounts receivables, cash, etc.
Test your skills – There are several entries under assets other than the ones mentioned here. Refer to your book and try to find those that will go under this head.
Liabilities
Liabilities are what a firm owes. These are debts or obligations that arise during the course of business. Balance sheet liabilities can be classified into the following –
Non-current Liabilities – These are long-term liabilities that are due after one year or even more. Examples of non-current liabilities include mortgage loans, deferred tax liabilities, bonds payable, debentures, pension benefit obligations, etc.
Current Liabilities – These are short-term liabilities that are due within a year. Examples of current liabilities include short-term loans, bank overdraft, bills payable, income tax payable, interest payable, payroll tax payable, etc.
Contingent Liabilities – As the name suggests, these liabilities arise owing to contingencies. An organization may or may not incur such liabilities, depending on the occurrence of contingent events.Examples of contingent liabilities include product warranties, lawsuits, etc.
Test your skills – Similar to assets, there are also several liabilities not mentioned here. To have a better understanding, try to find all the liabilities from any problems mentioned in your study material.
Shareholder’s equity
One of the crucial elements of a balance sheet is shareholder’s equity, which constitutes common shares, preference shares, and retained earnings. Shareholder’s capital can be calculated by subtracting liabilities from assets.
The following is a typical balance sheet sample –
Test your skills – Prepare a balance sheet in your notebook by referring to any problem in your accountancy book now that you know its format and structure.
Schedule III of the Companies Act, 2013
The amendments made to Schedule III of the Companies Act, 2013 laid down the format for preparation of profit & loss account and balance sheet with which all companies have to comply.
A typical example of the new structure is mentioned below –
Equity and liabilities:
Shareholder’s Funds
Money received against shares
Reserves and surplus
Share capital
Share Application Money After Allotment
Non-current Liabilities
Long-term provisions
Long-term borrowings
Deferred tax liabilities
Current Liabilities
Short-term borrowings
Short-term provisions
Assets:
Non-current assets
Fixed assets
Other non-current assets
Intangible assets
Tangible assets
Current assets
Short-term loans
Inventory
Current investments
Trade receivables
Other current assets
Limitations of a Balance Sheet
One of the primary limitations of a balance sheet is that it only accounts for assets that are acquired. Assets that cannot be expressed in monetary terms are excluded from the balance sheet.
A balance sheet does not show the actual market value of a company’s assets, which might hinder proper financial assessment.
Sometimes current assets are expressed in the balance sheet based on estimation. This discrepancy might distort liquidity projections of a company.
The above includes balance sheet definition and everything that you need to know about this financial statement. Make sure to keep checking out Vedantu’s website for more of these articles and blogs.
FAQs on Balance Sheet Basics Explained
1. What is a Balance Sheet?
The general balance sheet definition describes it as a financial statement of a company that lists its assets and liabilities against their monetary value for a particular period, especially at the end of a year.
2. What does a Balance Sheet Contain?
A balance sheet contains the assets, liabilities, and shareholder’s equity of a company.
3. What is the General format of the Balance Sheet?
In a balance sheet, assets are listed on the left and liabilities and shareholder’s equity on the right. However, as per the balance sheet format prescribed under the Companies Act 2013, it is vertical with the liabilities and shareholder’s equity recorded first and then the assets.
4. What is a Balance Sheet format?
A balance sheet is normally created by listing the assets on the left side and liabilities and shareholder’s equity on the right side. The Balance Sheet is also prepared vertically, with the liabilities and shareholder’s equity recorded first and followed by the assets. In the case of non-profit organizations, the assets are listed on the right while the liabilities are listed on the left. Moreover, instead of the capital, it is a capital fund or general fund. Before preparing a Balance Sheet, any surplus or deficit will be added or deducted from this fund.
5. Explain Assets.
What an organization owns are referred to as Assets, and these assets can be converted into cash in the short-run or in the long run. Assets can be of two types, namely,
i) ‘Fixed or Non-current Assets’, which are assets that are either “fixed” or immovable. Examples include land, machinery, equipment, building, goodwill, trademarks, etc. Assets can further be classified based on their type of existence (tangible or intangible) and their usage type. (operating or non-operating).
ii) Current Assets are assets that can be converted into cash (or the equivalent of cash) within a short period (usually a year). Examples include short-term investments, accounts receivables, cash, etc.
6. What are Liabilities?
Liabilities refer to what a firm owes and are debts or obligations which arise during the course of business. Liabilities of a Balance Sheet can be classified into :
‘Non-current Liabilities’, which are the long-term liabilities that are due after one year or even more. Some ‘Non-Current Liabilities’ examples include mortgage loans, deferred tax liabilities, bonds payable, debentures, pension benefit obligations, etc.
‘Current Liabilities’ are the short-term liabilities that are due within a year. Some basic examples of current liabilities include short-term loans, bank overdrafts, bills payable, income tax payable, interest payable, payroll tax payable, etc.
‘Contingent Liabilities’ are liabilities that happen to owe to contingencies. An organization may or may not incur such liabilities, as it depends on the occurrence of contingent events. Some examples of contingent liabilities are product warranties and lawsuits, etc.
7. Mention a few Limitations of a Balance Sheet.
Balance Sheets only account for the assets that are acquired, and the assets that cannot be expressed in monetary terms are excluded from the Balance Sheet. A balance sheet does not show the actual market value of a company’s assets, due to which the proper financial assessment could create some misunderstandings and problems. At times, the current assets which are expressed in the Balance Sheet are purely based on estimation, and this discrepancy might sometimes distort the liquidity projections of a company.
8. Where can I get Study Materials for Commerce topics like Balance Sheets?
The topic ‘Balance Sheet- Definition, Importance, Format Structure is important, especially for the Commerce students. It is very important to be able to practice some of the important questions so as to understand all concepts and formulas, and to do well in the examinations.
The online portal, Vedantu.com offers important questions along with answers and other very helpful study material on this topic on the Balance Sheet, which have been formulated in a well structured, well researched, and easy to understand manner. These study materials and solutions are all important and are very easily accessible from Vedantu.com and can be downloaded.
