The balance sheet (abbreviation: BS) is a report that tells your financial position on a given date.
Regardless whether your business is a sole proprietorship or a corporation, you need money to run your business. The balance sheet tells you how your money is allocated and where the money comes from.
3 components of a balance sheet: Assets, Liabilities, Equity and their equality
The balance sheet looks like below.
The amounts of the left and right sides must always be the same, as expressed in the equation below.
Assets = Liabilities + Equity
You should pose for a moment to understand why the equation above is always true.
It is so because the money you acquire (liabilities + equity) must be allocated into something (assets). If you borrow money from a bank (liability) and keep it without spending in your bank account (asset), the amount of borrowed money and the amount in your bank account must be equal. Likewise, if you spend all the money on buying equipment (asset), the value of the equipment and the amount of the borrowed money are, again, the same. The same reasoning applies even if your business acquires money by using equity such as your own savings.
Here is an example of a balance sheet generated on Cagamee accounting.
Here, the Assets section is vertically stacked on top of the Liabilities and Equity sections, but otherwise it's the same as the horizontal format. The retained earnings is dynamically calculated from the income statement and is also a part of the Equity section. Thus, the amount of the assets (2,805,000) equals that of liabilities (160,000) and equity/net assets (2,370,000 + 275,000).
The meaning of the name 'Balance Sheet'
As you have guessed by now, the name 'balance sheet' comes from the fact that the left side (Assets) and the right side (Liabilities and Equity) must balance.
Next, let's see what kind of ledger accounts belong to each section of the balance sheet.
Assets are things you own in order to run your business.
Examples of asset accounts are the followings:
- Cash: Bills, coins
- Bank accounts: checking accounts, savings accounts
- Accounts receivables: Money your customers owe to you.
- Inventory: goods, merchandise
- Equipment: Computers, printers
Liabilities are debts that you owe to someone else.
Examples of liabilities are the followings:
- Accounts payable: Money you owe to your vendors
- Salaries payable: Money you owe to your employees
- Bank loans: Money you owe to banks.
- Tax payable: Money you owe to the government.
Equity (Net Assets)
Equity is the amount of money owners of your business have a right to. Also called net assets, it’s expressed as Assets - Liabilities as the name implies. It means that if you liquidate your assets and pay back your liabilities, the remaining amount is your equity and is distributed to the owners of the business.
Examples of equity accounts are the followings:
- Capital stock: Money the shareholders have invested in your company.
- Retained earnings: Accumulated profits of your business
To sum it up, you should remember the following points regarding the balance sheet.
- The balance sheet represents a snapshot of your financial position on a specific date.
- Assets = Liabilities + Equity and the equation must always hold true.