A balance sheet is useful in expressing the financial position of a company at a point of time. On one side is assets (cash, inventory, land, etc). On the other side are liabilities (loans to be paid back, accounts payable, etc) and shareholder's equity (retained earnings, stock sold, etc). Both sides must equal out exactly (thus the name BALANCE sheet), as the balance sheet must follow the fundamental accounting equation (Assets = Liabilities + Equity).

The balance sheet alone is only somewhat useful to someone viewing it. It can give someone a basic idea of what the company has (cash, materials, etc) and how they financed their costs (loans or stock).

As the balance sheet is at a point in time (ie. "Balance Sheet as of January 1, 2001"), it's useless in examining a company's trends alone. Rather it needs to be compared to previous balance sheets, and used together with other financial statements (for example, the statement of cash flows is better for looking at where cash comes from and where it goes).

As with most financial data, there's a certain amount of leeway a company has in the numbers (for example, how a company accounts for depreciation of materials could affect the numbers in several categories), further stressing how a company's balance sheet should be taken with a grain of salt.

Node your homework!

How to prepare a balance sheet

  1. Find and record total assets.
    1. List the current assets and draw a single line under the last entry.
    2. Total the current assets and draw a single line under the total.
    3. List the fixed assets and draw a single line under the last entry.
    4. Total the fixed assets and draw a single line under the total.
    5. Total current and fixed assets, and draw a double line below the grand total.
  2. Find and record total liability.
    1. List the current liabilities and draw a single line under the last entry.
    2. Total the current liabilities and draw a single line under the total.
    3. List the long-term liabilities and draw a single line under the last entry.
    4. Total the long-term liabilities and draw a single line under the total.
    5. Total current and long-term liabilities, and draw a single line below the grand total.
    6. Find and record the total owner's equity.
      1. Make a list of owners' equities, one per line, with a single line after the list.
      2. Total the equities and draw a single line below the total.
    7. Sum current and long-term liabilities with owner's equity, and draw a double line underneath the total.
  3. Confirm the balance.
    1. Total Assets should be equal to Total Liabilities, which include owner's equity.

Let's take a closer look at the how and why of this process. As you know, a balance sheet is used to determine the status of a company and is an important step towards determining its health. It's called this because a balance sheet was historically written in two columns, with assets on the left and liabilities on the right. If the two sides didn't "balance", something was wrong. Prior to the invention of the joint stock company (currently known as the corporation) this was reasonable because owner's equity was generally limited to a small number of partners, and also because only the largest firms had long lists of assets.

Owner's Equity refers to the interest in the company by the owner or owners. In the case of a simple business, there may be only one owner. Corporations have many owners, because every stockholder is an owner. Of course they do not all need to be considered on a balance sheet; Simply enumerating the outstanding shares of different types and their value is sufficient. It is a liability because it can be considered money owed to the owners by the company, even in the case of a business owned by a single individual.

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