The purpose of any financial statement is to provide information about an entity’s transaction history that is USEFUL for internal and external users. You can read more about accounting and the purpose of Financial Statements here (refer to What is accounting blog) Financials must also be made using the Accrual Method of Accounting, if prepared for external users. (refer to accrual blog)
Depending on your age, business structure and personal preference, the Balance Sheet can also be called the Statement of Financial Position.
THE BALANCE SHEET IS A TOOL
The Balance Sheet is a tool to explains the financial BALANCES of an entity at a SINGLE POINT IN TIME. In other words, what are our financial accounts and relationships as of RIGHT NOW?
WHAT IS THE BLANCE SHEET EQUATION?
The Balance Sheet explains the Fundamental Accounting Equation where:
Assets = Liabilities + Equity, using the following accounts:
WHAT IS AN ASSET
- Asset = probable future economic benefit as a result of operations. In other words, THE CORE BUSINESS IS GOING TO BENEFIT FINANCIALLY OR ECONOMICALLY FROM THE USE OF THE “ASSET” (I.E. MACHINERY THAT GENERATES PRODUCTS TO SELL WHICH CREATES REVENUE)
WHAT IS A LIABILITY?
- Liability = probable future economic sacrifices as a result of operations arising from a present obligation to transfer assets the company owns. In other words, THE CORE BUSINESS IS GOING TO REDUCE ITS ASSETS FROM THE OBLIGATION OF THE “LIABILITY” (I.E. TAKING A BUSINESS LOAN TO PURCHASE THE MACHINERY OBLIGATES THE COMPANY TO MONTHLY PAYMENTS, REDUCING ITS CASH-FLOW EACH MONTH (CASH = AN ASSET))
WHAT IS EQUITY?
- Equity (aka Capital aka Shareholder aka Partners Accounts) = residual interest in the net assets of the company. NET ASSETS = ASSETS LESS LIABILITIES. In other words, the company has positive Equity Balances when Assets are greater than liabilities.
WHAT IS THE BALANCE SHEET USED FOR?
The Balance Sheet helps the user understand how the entity has efficiently leveraged its Assets, Liabilities and Equity accounts to produce profits, as seen by the Income Statement (refer to Income St. blog)
WHAT ARE SOME HELPFUL RATIOS?
Financial statement ratios help users to gather the information important to analyze the entity’s past, current and future operations: Some ratios used from the Balance Sheet accounts include: (refer to Fin Ratios blog)
- Gross Profit Margin
- Working Capital
- Current Ratio & Quick Ratio
- Accounts Receivable Turnover (ratio and in days)
- Accounts Payable Turnover (ratio and in days)
- Inventory Turnover (ratio and in days)
- Operating Cycle
This publication is designed to provide information of federal tax and accounting laws and/or regulations. It is presented with the understanding that the author is not rendering legal or accounting services.
This text is not intended to address every situation that arises or provide specific, strategic tax and/or accounting planning advice. This text should not be used solely to answer tax and/or accounting questions and you should consult additional sources of information, as needed, to determine the solution to tax and/or accounting questions.
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