Balance sheet preparation is a critical process that must be carried out on a quarterly or monthly basis. This financial report details your assets, liabilities, and stockholders’ equity.
Are you unfamiliar with the process of creating a balance sheet?
Below, we’ll discuss the purpose of balance sheets and then walk you through the process of constructing your own.
Balance sheet meaning
A balance sheet in accounting is a picture of your business’s financial position. It aids in financial planning and enables a firm to view the equity of its owners. It is one of three essential financial statements that any business owner must have to do financial modeling and accounting; the other two are an income statement and cash flow statement.
In its simplest form, an accounting balance sheet is one of the most precise methods for analyzing a business’s financial condition. When fully developed, a balance sheet accounts can reveal the following:
- What the enterprise owns.
- What the enterprise owes.
- How much money has been invested in the business?
As the name implies, your business’s assets should always equal the number of its liabilities and equity. The balance of the sheet must constantly be maintained. Assets should equal liabilities plus stockholders’ equity in a firm. If either is erroneous, your calculations or notations will be wrong.
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Balance sheet purpose
A balance sheet is a picture of the financial situation of a business at a certain point in time. Internally and publicly, it is a crucial metric, although for very different reasons:
Balance sheets enable you to determine if a firm is thriving or floundering. By examining your liquidity situation (cash and receivables), you can determine if you can afford future costs or whether a market shock. Additionally, you may evaluate past asset and liability patterns to ensure that your firm is operating effectively or to rapidly identify issue areas. If the figures do not seem good, it may inspire an internal rethinking of how the business is conducted.
Balance sheets are used to inform investors, stakeholders, and external authorities about a business’s financial situation, the resources that are now accessible, and how those resources were funded. This information can assist investors in determining whether or not to invest in the firm. They can extend these figures to calculate additional financial indicators such as the debt-to-equity ratio, profitability, and liquidity. For external auditors, a balance sheet can assist them in determining if the business is compliant with applicable reporting rules.
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What is contained on a balance sheet?
Almost every balance sheet is reducible to the following equation:
Assets = Liabilities + Shareholder’s equity
The asset part of a balance sheet details the valuable possessions of your firm. Typically, these assets are ordered in order of liquidity—how readily they may be turned into cash. It is generally further subdivided into two asset categories:
The liability part of the balance sheet summarises your present financial obligations to others, which may include recurrent costs and different types of debt. Liabilities are classified into two types. They are classified as either long-term or current liabilities.
Equity of shareholders
This represents the worth of the cash invested by shareholders in the business, as well as retained earnings. Dividends must be paid from retained earnings.
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Total Assets – Total Liabilities = Total Equity
Now that you’re familiar with the contents of a balance sheet, how can you create your own? Take the following steps:
Step 1: Determine the date of the balance sheet
A balance sheet is used to summarise your business’s assets, liabilities, and shareholders’ equity on a certain day of the year or during a specified period. The majority of businesses provide quarterly reports, generally on the last day of March, June, September, and December. Additionally, businesses may choose to create monthly balance sheets, in which case they would report on the last day of each month.
Step 2: List of all your assets
After you’ve established the date, the following step is to divide all of your existing asset items into distinct line items. To make this part more useful, it’s preferable to group them by liquidity level. Liquid assets such as cash and accounts receivable are prioritized, whereas illiquid assets such as inventories are prioritized last. Following the listing of a current asset, you’ll need to include non-current (long-term) assets. Include non-monetary assets as well.
Step 3: Add a list of all of your assets
Add up all of your asset categories after you’ve detailed them. The final count will subsequently be filed under the category of total assets. To confirm that your figures are accurate, compare them to the company’s general ledger.
Step 4: Determine current liabilities
Current obligations are those that are due within one year of the balance sheet date. Accounts payable, short-term notes payable, and accumulated obligations are all examples of these.
Step 5: Calculate long-term liabilities
Make a list of the obligations that will not be resolved during the fiscal year. Among these are long-term notes, payable bonds, pension schemes, and mortgages.
Step 6: Calculate the liabilities
Total liabilities are calculated by adding the current liabilities subtotal to the long-term liabilities subtotal.
Step 7: Determine the owner’s equity
Calculate the retained earnings and working capital of your firm, as well as the overall shareholders’ equity. Earnings retained are profits retained by a firm for reinvestment (not distributed as dividends to shareholders). The term “shareholders’ equity” refers to the sum of share capital and retained earnings.
Step 8: Total the liabilities and the equity of the owners
If liabilities + equity equals assets, the balance is right. If it does not, you may need to revisit your work.
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Balance sheet example
Reports are always constructed identically. The business name comes first, followed by the statement’s title, and in the case of a Balance Sheet, we would include the date for which the Balance Sheet is being prepared – as of ABC date.
The Balance Sheet is divided into three sections: Assets (items we own) + Liabilities (things we owe). As a result, this statement is a representation of the accounting equation.
Per the report, the total assets (INR) and total liabilities and owner’s equity are identical.
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