Guide – What is a balance sheet?
A balance sheet is a financial statement that reports a company’s assets, liabilities, and owners’ equity. Also known as the statement of financial position, it provides a snapshot of the company’s financials as of a certain date. This article will brief you to a beginner’s guide to preparing a balance sheet.
Guide – What are the components of a balance sheet?
A balance sheet is made up of three elements namely assets, liabilities, and owner’s equity.
An asset is formally defined as a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity. In the balance sheet, there is no fixed format on which accounts to present first but the general idea is to report the assets according to their liquidity. With this, assets can be divided into two components: Current Assets and Non-Current Assets.
The current assets are cash and other assets that are expected to be converted to cash within a year. Normally, these will include cash and cash equivalents, accounts receivable, inventory, prepaid expenses, and short-term investments.
Meanwhile, non-current assets are those assets from which realization of the full value of the asset will require more than a year. In other words, these are long-term assets covering both tangible and intangible items. Non-current assets normally comprise of the non-current portion of notes receivable, property, plant and equipment, land, and depending on the business operations, there can also be goodwill or other non-marketable securities forming part.
A liability is defined as a present obligation of an entity arising from past events the settlement of which is expected to result to an outflow of resources that embody economic benefits. Like assets, liabilities are also divided into the current portion and non-current portion in the balance sheet. Likewise, the accounts are also presented in order of liquidity.
Current liabilities are short-term financial obligations which are due to be settled within a year or within the company’s normal operating cycle. Examples of current liabilities are accounts payable, the current portion of a notes payable, salaries payable, interest payable, accrued taxes, and other deferred expenses.
On the other hand, non-current liabilities are financial obligations of an entity which are not due for more than a year or which will become payable beyond a normal operating cycle. These can be viewed as long-term liabilities and will include long-term debt, mortgage payable, non-current portion of deferred revenue and income taxes, to name a few.
Finally, owners’ equity or also referred to as shareholders’ equity or stockholders’ equity by others, is the residual claim after all debts have been paid and deducted from the value of a company’s assets. In other words, equity equals a firm’s total assets less its total liabilities. In the balance sheet, this part can be broken down into share capital, share premium, and retained earnings.
Basic guide – How do you prepare a balance sheet?
Our goal is to draft our own statement of financial position. To provide some guidance, we break this down into 5 easy to follow procedures.
STEP 1: Prepare the header
All financial statements come with a header. You can think of it as a title to a book or the report you are making. The header comprises of three lines. The first line will the name of your company. The second line will be the title of the report. In this case, we place “Balance Sheet” or “Statement of Financial Position” and finally, we place the reporting date on the third line.
Note that since the purpose of the balance sheet is to present the financial position of the company as of a certain date, we place the phrase “as of” before the date. This varies when we’re talking about the income statement or the statement of cash flows where we are presenting the performance or activities for a time period. In which case, we use the phrases “for the year ended” or “for the month ended” depending on what is appropriate.
STEP 2: Identify your assets
Now we move on to the actual content of the balance sheet. We start by grouping the assets into two categories: Current and Non-Current Assets and listing accounts as a line item each according to their liquidity. Afterwards, we get the subtotal of each category before finally summing these two together. The output should look something like this:
STEP 3: Identify your liabilities
Similar to how we did the presentation of assets, we also group the liabilities into two categories: Current and Non-Current Liabilities and present each account according to their liquidity. Likewise, we get the subtotal of each category and total them together afterwards.
STEP 4: Compute owners’ equity
Next step will be to compute for the owners’ equity, which normally comprises of share capital for ordinary shares and for preferred shares, share premium, treasury stocks, retained earnings and/or whatever is applicable in your situation.
STEP 5: Check if total assets equal total liabilities and capital
Going back to the basic accounting equation, we note that the sum of the total liabilities and owner’s’ equity should equal the company’s total assets. If this isn’t the case, then we will need to revisit each component and see where we went wrong in the process.
A Beginner’s Guide in Preparing Balance Sheets
This concludes our short guide! Congratulations on creating your own balance sheet! You should now have something that looks like this.