Updated July 14, 2023
What is Balance Sheet in Accounting?
The balance sheet is the statement that is prepared by the business organization, which states the monetary values of all the assets that the company owns, all the liabilities that the company owes, and the equity of shareholders at the given point in time when the sum of liabilities and equity of shareholders is always equal to the total of all the assets of the company, and there are many reasons to prepare balance sheet where the main purpose is to know the financial status of the company.
The balance sheet of the business shows the assets owned by the company, the liabilities owed to outsiders, and the amount invested by the shareholders in the company. The purpose of the balance sheet is to know the business’s financial position at any given time. The assets and liabilities can be current or non-current assets; there are many users of the balance sheet of the business besides the owners, such as investors, lenders, vendors, employees, etc. the balance sheet has many purposes, such as it helps in knowing the equity and debt status of the company, i.e., how much fund is raised through the issue of equity shares and how much is from a debt issue. Also, the company’s liquidity position, cash and bank balance position, the value of fixed assets, the number of accounts receivable, the number of accounts payable, and the company’s overall net worth are known from the company’s balance sheet.
Purpose of Balance Sheet
The purpose of a balance sheet is explained below:
Balance Sheet of ABC Ltd as of 31st December 2019
|2019 ($ million)
|2018 ($ million)
|Total shareholder’s equity
|Long term debt
|Other non-current liability
|Total Non-Current Liabilities
|Total Current Liabilities
|Total shareholder’s equity and liabilities
|Property and Equipment
|Total Non -current Assets
|Total Current Assets
The purpose of preparation of the balance sheet is as follows:
- The business firms and entities prepare the balance sheet to know the position of the shareholder’s equity, liabilities, and assets at the given time. With the help of the balance sheet, the management makes the financial decisions that must be taken for the growth and survival of the business. The above balance sheet shows the monetary values starting from the equity of shareholders followed by non-current liabilities, current liabilities, non-current assets, and at the end, current assets. From the balance sheet, management knows about the debt status, the company’s liquidity position, and the retained earnings status. So for the management balance sheet is essential to predict the problems that can occur in the near future and then plan the remedial course of action.
- The various ratios, such as current ratios, fixed assets turnover ratio, and other liquidity ratios, etc., need the values of current assets, current liabilities, fixed assets, etc., available on the balance sheet. So balance sheet gives the figures that are needed to calculate various ratios. These ratios are helpful for the management to know the earning capacity of the business. They are also useful for analyzing the contribution of various assets toward the company’s profit. For example, the current ratio is calculated by dividing current liabilities by the current assets. The figures for current liabilities and assets are given on the balance sheet. So the current ratio of 2 years is as follows:
|Current Assets (a)
|Current Ratio (a/b)
So, the users can analyze that the company’s liquidity position is good as the ratio for 2019 and 2018 comes out to be 2.56 and 2.46, respectively.
- A balance sheet helps the investors know the company’s actual position of assets and liabilities. Analyzing such a position helps the investors to know how much return they can get on their funds if they invest in the shares of such a company. Even the past year’s balance sheets are compared to know the company’s trend so that the investors can get an idea of the company’s growth and stability. Since the balance reported generally consists of 2 years like that prepared above. So each figure can be analyzed, and the growing and the decreasing trend is then evaluated.
- The balance sheet helps determine the business’s risk and returns as the balance sheet is bifurcated among the various heads, including assets, liabilities, and owner’s equity. Then assets and liabilities are further categorized as long-term and short-term. Short-term and long-term assets reflect the company’s ability to generate cash in the near future. In contrast, short-term and long-term liabilities are the financial obligations that the company needs to pay. So balance sheet helps to analyze the actual position of the company’s assets and obligations and make decisions accordingly. For example, if the cash is less than the financial obligations, the management must arrange for the funds to pay off the obligations.
- Even the lenders demand the company’s balance sheet before giving it any kind of loan because the balance sheet provides them with information about the present debt status of the company and its repaying capacity. A balance sheet helps lenders to know the creditworthiness of the company. The loan repaying capacity is directly linked to the balance sheet quality.
- The balance sheet is also used by the government authorities such as income tax authorities, stock exchanges, etc. The government checks the balance sheet for income tax purposes. For also knowing that the company’s affairs don’t involve any malpractice. Even the stock exchanges keep an eye on the company’s balance sheet so that any fraud and error can be detected on time.
- While conducting the audit, the first thing that the auditor asks for is the balance sheet of the company. Since the auditor has to give an unbiased opinion on the matters of the company, they ask for the company’s balance sheet, and then by evaluating it, they give their opinion in the audit report.
Thus, a Balance sheet is the financial data prepared in a prescribed format to know the position of the company’s assets, liabilities that are payable, and the owners’ equity, including the shares issued by the company and its retained earnings. There are many users of the balance sheet, and the primary user is the management itself, who needs the balance sheet to know the actual financial position of the business. A balance sheet helps evaluate the business’s growth potential and make strategies accordingly if the same is required to grow the business in the right direction. There are other users too, which can be external and internal, but directly or indirectly, they have an interest in the company’s affairs.
This is a guide to Balance Sheet Purpose. Here we discuss the introduction and purpose of the balance sheet along with an example. You may also have a look at the following articles to learn more –