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Simple Guide on Balance Sheet

Simple Guide on Balance Sheet

A balance sheet is a mandatory financial statement for any business entity. Let's learn about creating a balance sheet, managing assets and liabilities etc

A balance sheet is a financial statement. It summarises the financial position of a company or a person undertaking some business as defined under the Income Tax Act 1961. The Balance sheet reports the assets and liabilities of the company at a specific period. The period can be different for different entities, but generally, it is prepared at the end of a financial year (April to March).

Preparing a balance sheet is extremely important for any business. A balance sheet displays the financial capacity and net worth of a company. It also helps evaluate the health of the business. 

Basic Requirement of a Balance Sheet

A balance sheet comprises assets, liabilities and equity. These three are the fundamentals of a balance sheet. And a balance sheet must satisfy the following equation:

                                                    Assets = Liabilities + Equity

Assets: The resources owned by the business entity are called assets. Assets comprise tangible assets like machinery and intangible assets like a part of the business that can’t be measured but adds value nonetheless. Example: Goodwill. Both current assets and noncurrent assets are also included in this. 

Liabilities: Liabilities are obligations the business entity owes to outsiders or its partners/members. Liabilities also contain current and noncurrent liabilities.

Equity: Equity comprises the retained earnings and the invested amounts that help determine the company’s net worth. In short, it is the leftover assets with owners after paying the outsider liabilities. These may be used as savings for paying future obligations, and that’s why they are shown on the liabilities side of the balance sheet.

Hence, the balance sheet contains two parts, one that shows assets and the other that shows liabilities and equities. The total of both parts must be equal. 

Marshalling of Assets and Liabilities

The order in which the assets and liabilities are arranged in the balance sheet is known as marshalling. It is done in three different ways:

1) In order of liquidation:

In the liquidation method, liquidating capability of assets and liabilities is considered first. Assets which can be liquidated quickly are placed at the top of the sheet in the method. Liabilities are ordered on the urgency with which they have to be paid back. The most urgent liability is placed at the top.

2) In order of permanence:

This method is simply the reverse of the liquidation method. In this case, assets which can be liquidated quickly are placed at the bottom, while those assets which will be with the company for a long time are placed first. The least urgent liability, meanwhile, is placed top.

3) In mixed order:

This method sees a mixed approach. The assets are arranged according to the order of liquidation, while liabilities are arranged according to the order of permanence.

Format of Balance Sheet

A balance sheet can be represented by two methods:

  • Vertical Representation
  • Horizontal Representation

Vertical Representation

In a vertical representation format, the presentation is in a single column of numbers, starting with assets and ending with liabilities. 

The major heads and sections are:

Assets:

Non-Current Assets: Assets which are held for a longer period. This period is usually more than one year.

Current Assets: The assets that can be liquidated or converted into cash within a year.

Liabilities: 

Equity: This section contains surplus, retained earnings, share capital and share premium. 

Noncurrent Liabilities: Long term obligations that take time to settle, i.e., more than a year.

Current Liabilities: Short term debts or obligations which need to be paid within a year.

Horizontal Representation

  • This format records the data in a T-Shape format, i.e., the liabilities on the left-hand side and the assets on the right-hand side.
  • Horizontal balance sheets are used when there are a lot of line items to be included in the sheet. If the line items are lesser, a vertical balance sheet makes sense.
  • Here the total of liabilities must be equal to the total of assets.

Steps to Prepare a Balance Sheet

  • Select the period for which the statement has to be prepared.
  • Pin down the assets: current and noncurrent assets (despite tangible or intangible)
  • Pin down the liabilities: current and noncurrent liabilities
  • Determine shareholder’s equity
  • Sum up the balances: The total of both parts should always be equal.

If it is not, it can be due to some calculation mistakes, missing entries, double entries, miscalculations in amortisation and depreciation of assets, and mistakes in inventory calculations.

Conclusion

A balance sheet displays a detailed summary of the assets and liabilities of a business entity, which is very important in determining the entity’s financial position. It is mandatory to prepare a balance sheet under the law and to complete an accounting cycle to keep transparency between the entity and the government. Proper knowledge of accounting is required to prepare a balance sheet.