Any type of business requires capital to run. It does not matter whether you own a shop, leading a large software firm, or running a small business as a solopreneur.
Keeping the size and scale of business aside, it is necessary to keep the timely check in the top-line, bottom – assets being owned, liabilities owed to others, and net-worth (owner’s equity).
All these factors define the financial state of the business. The statement of financial position is also called the balance sheet. The major factors covered in a balance sheet are assets, liabilities, and owner’s equity. It is normally prepared at the end of the accounting period usually end of the financial year. In a modern day business, some businesses do keep a check by preparing monthly, quarterly and half-yearly balance sheet.
Deep-Dive Into Fundamentals Of Balance Sheet
The format/syntax being followed in the balance sheet is the same/uniform, making it easy for the business to prepare balance sheets. Hence, the balance sheet further assists the key stakeholders to arrive at critical decisions for the goodwill of the business. The key components of a balance sheet are:
Assets – These are the valuables owned by the company. Assets can be categorized into tangible and intangible assets. Brand value, trademarks, copyrights, etc. are some of the prime examples of intangible assets. Cash in hand/accounts, accounts receivable, or any types of assets that can generate liquid cash for the business are termed as current assets.
Long-term assets are capable of generating revenue in the long-run. Patents/IP held by research organizations is one of the most valuable intangible assets for the company. Except for land, all other fixed assets are mentioned in the balance sheet at the original cost less depreciation.
|Assets = Liabilities + Owner’s Equity|
Liabilities – Liabilities can be considered as the debts owed by the business. It can be classified into long-term and current liabilities. Current liabilities are taxes payable, accounts payable, debt that is due within a year, etc.
Long-term liabilities are the dues that are owed by the business for more than a year from the preparation of the balance sheet.
|Liabilities = Assets – Owner’s Equity|
Equity – It is the value of the assets owned by the owner/promoter of the business. In a nutshell, the owner can repay the debts after selling off the assets and the remaining portion is the owner’s equity.
|Owners’ Equity = Assets – Liabilities|
A sample balance sheet is illustrated below:
As seen from the sample balance sheet shown above, assets & liabilities are the major components of the balance sheet.
Balance Sheet Preparation
Since the balance sheet is prepared using the financial data of the organization, the source of the balance sheet is the account books. Below are the main steps for balance sheet preparation:
- Preparation of a Ledger Account – The closing balance is determined from the statement of accounts for each ledger. The statement of accounts is prepared from the journal book.
In short, this step involves posting of all the debit and credit transactions into a statement that belongs to that particular ledger account.
- Creating a Trial Balance – Once all the ledger accounts are created, that information is used to create the Trial Balance. Trial Balance is nothing but a summary of all the ledger accounts that have been created in step-1. It contains the closing balance along with the respective ledger accounts.
Trial balance primarily constitutes of three columns – debit, credit, and closing balance of each ledger account.
- Creating a P&L (Profit & Loss) statement – The Profit & Loss (P&L) statement is the actual reflection of the performance of your business. It contains a summary of the costs, revenue, expenses that were incurred during a particular time frame i.e. fiscal quarter/year.
- Preparing the balance sheet – This step is very important since it is the final step where the balance sheet is prepared. The ledgers that were considered for step-3 (creation of P&L statement) should not be used in the final preparation of the balance. Apart from the ledgers that were not considered for the P&L statement preparation, all the other ledgers should be considered.
Even experienced accountants may tend to make mistakes during the balance sheet preparation. Hence, businesses should make use of good accounting software like Tally.ERP 9 that includes good features like auto-generation of reports,analytical tools such as quick comparison across the period and the companies, quick navigation to related reports to get better insights etc., easy to use and has GST filing feature so that the task of balance sheet preparation does not look complex.