A simple guide to your balance sheet

A Balance Sheet

What is a Balance Sheet?

Are you trying to figure out what a balance sheet is and how to interpret it? If so, you’ve come to the right place!

A balance sheet is a financial statement that shows a company’s financial position at a specified point in time.

It will be produced as part of the ‘year – end’ accounts to show the position of the company at the end of its financial year. However, they can be produced at any time to give a current illustration of the company’s financial affairs.

Interpreting a balance sheet allows the reader to get an idea of the value of the company and understand its financial operations. They are a vital decision making tool for investors to determine whether they want to be involved in the company.

The financial position of a company is detailed in terms of three key areas:

  • Assets
  • Liabilities
  • Shareholder’s Equity

The balance sheet works on the basis that the following formula must be satisfied:

Assets = Liabilities + Shareholder’s (Owner’s) Equity

… and is so called because the two sides of the equation must balance out.

balance sheet

The equation: Assets = Liabilities + Shareholders (Owner’s) Equity

What is an Asset?

Assets

An asset is anything that a company owns that has a value. Here are some examples of assets:

  • Equipment e.g. machinery, vehicles
  • Stock / Inventory
  • Cash that the business has in the bank
  • Property e.g. any premises the business owns in relation to the business.

A company’s assets signify an important part of the balance sheet equation. The value of the assets that a company has provides an indication of the value of the company.

What is a Liability?

Liabilities

A liability is an amount of money that a company owes.

In many cases liabilities take the form of money that has been borrowed to support the operation of the business. It could be money that is owed to a lender such as a bank, other lender or even to a supplier.

The summation of all liabilities is the total of all money owed. This value compared to the total value of the assets gives a good indication of the stability of the business.

What is Shareholders Equity?

Shareholder's Equity

Shareholders Equity, sometimes referred to as Owners Equity is calculated as the Total Assets minus the Total Liabilities. It represents the amount of money that would be left if all the company’s assets were liquidated and all the debts were repaid. In can also include monies contributed to the company by its investors along with earnings and dividends issued to shareholders.

This figure represents the net value of the company and is an important metric that is used to determine the health of the company.

Shareholders Equity can be negative or positive. A positive value means that the company has more than sufficient asset value to cover its liabilities. Investors could see this as positive, making the company a potentially good investment proposition. A negative value would mean insufficient assets to cover the liabilities if liquidated, making the company potentially unstable.

Balancing the Balance Sheet

Every financial transaction that a company makes results in an equal change to the assets or liabilities section of the balance sheet.

For example, if a company took out a loan for £10,000, this would increase the cash assets by £10,000 but it would also increase the liabilities by the same amount.

Example Balance Sheet

The table below shows an example balance sheet with some typical entries included. Depending on the company and its financial affairs, some of the entries may not be applicable. Similarly, other entries may be required that are not shown.

Note that the balance sheet adheres to the formula that was discussed earlier in the article:

Assets = Liabilities + Shareholders Equity

The assets in the left – hand column are equal to the sum of the liabilities and the shareholder’s equity in the right – hand column.

example balance sheet

 

What can I learn from a company’s balance sheet?

To recap, the balance sheet is an important part of a company’s financial reporting. It gives a picture of the company’s financial position and shows its assets, its liabilities and the amount of money invested in the company. The balance sheet is one of a number of tools used by potential investors to decide if they want to invest in the company.

Free Balance Sheet Template

To help you understand and create your own balance sheet, we have a free, downloadable excel spreadsheet template. Each cell in the spreadsheet is annotated with an explanation of what goes into that cell. Click here to download your free template!