What is a Balance Sheet?

A balance sheet is a financial document that summarizes the total assets, liabilities, and shareholders’ equity of the company. It can also be referred to as a statement of financial position or net worth, giving a snapshot of how the business is performing financially. It is typically prepared on a quarterly or monthly basis, depending on the frequency of reporting as stated by company policy or law. 

This financial statement is governed by accounting standards such as Generally Accepted Accounting Principles (GAAP) in the US and International Financial Reporting Standards (IFRS) in many other countries.

Balance Sheet Equation

Assets = Liabilities + Equity

This equation must always balance. Assets should always equal liabilities plus equity. Liabilities should always equal assets minus equity. Equity must always equal assets minus liabilities. For instance, if assets do not equal liabilities plus equity, it signals accounting errors or misstatements. Therefore, prompting an immediate investigation.

Three Main Components of a Balance Sheet

1. Assets are resources controlled by the company expected to generate future economic benefits. They are typically tallied as positives (+) in a balance sheet. Assets are broken down into two categories:
   • Current assets: These are assets that are expected to be consumed or converted into cash within a year. Some examples are:
     • Cash and cash equivalents
     • Accounts receivable
     • Inventory
     • Marketable securities
   • Noncurrent assets: Also referred to as long-term assets that are held for more than a year and not easily liquidated. Examples include:
     • Intangible assets or non-physical assets like patents, trademarks, and goodwill
     • Equipment used in services and production, such as Property, Plant, and Equipment (PPE)
2. Liabilities represent a company’s obligations or debts, indicating amounts the entity is legally required to pay. These are also categorized by maturity:
   • Currently liabilities: Debts that must be settled within one year, which include:
     • Accounts payable
     • Payroll expenses
     • Rent and utility payments
     • Debt financing
   • Non-current liabilities: Long-term liabilities that won’t be due for more than one year, such as:
     • Bonds payable
     • Mortgages or loans
     • Deferred tax liabilities
     • Provisions for pensions
3. Equity represents the residual interest in the company’s assets after deducting liabilities. It consists of:
   • Common stock
   • Retained earnings
   • Additional paid-in capital

How do balance sheets work?

Balance sheets adhere to the principle of double-entry bookkeeping, where each transaction affects at least two accounts. Hence, keeping the balance sheet equation intact. When a business acquires assets, it finances them either by incurring liabilities or using equity, which is reflected in the sheet.

For example, purchasing equipment (a non-current asset) using a bank loan (a liability) increases both assets and liabilities. Or, if the business generates profit, that profit will be added to retained earnings under equity, while the company’s cash (an asset) will increase.

Who prepares the balance sheet?

The balance sheet is prepared by the company’s internal finance or accounting team, and is overseen by a Chief Financial Officer (CFO) or Financial Controller. For publicly listed companies, audit opinions of external audits are required to ensure compliance with standards. 

What is the difference between a balance sheet and a financial sheet?

While the balance sheet is a core financial statement, it represents only part of the broader financial statements set, such as the income statement (profit and loss) and cash flow statement. In other words, the balance sheet provides a snapshot at a single point in time, whereas financial statements like income statements cover performance over a period.