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Balance Sheet: The Balance Sheet Explained with a Clear Tutorial

Posted On November 3, 2018 at 7:36 pm by / No Comments



Balance Sheet:
The Balance Sheet Clarified with a Clear Tutorial

The Balance Sheet is on of the 3 Main Financial Statements.

A balance sheet shows (denominated in currency) what a business:
1) Owns/Controls (Assets)
2) Owes/Obligated to do (Liabilities)
3) And what’s left when you subtracted [2] from [1]: What is left for the owners’ of the business (Equity)

That’s really all there is to it!

First, look at the assets (what the company owns). Assets have a complicated definition in the financial accounting handbook but essentially assets are what generate future income of the business. A company buys, or holds, assets in the hope that they will produce more income than they cost to buy, or hold. Simple. Look at “Inventory” (Current Asset) in an example Balance Sheet; this account represents goods that a business has bought in the hope that it can later re-sell them at a higher price. Or “Property, Plant & Equipment” (Non-Current Asset), this account represents the property, plant & equipment (go figure!) that a business has bought that will hopefully help their business run smoothly (such as a warehouse and logistics machinery), which will in turn hopefully lead it to sell more products.

Next, look at the liabilities (what the company owes). Again, there is a complicated definition for liabilities in the handbook, but generally what it refers to are obligations that lead to outflows of currency at later date(s) to satisfy these same obligations. In small, you can reckon of them as simply the debts of the business.

These debts can represent how you funded the assets on the other side of the balance sheet (note: you can also fund them through equity), for instance, you took on a bank loan of $100,000 (liability) to buy a retail shop for business (an asset in the property, plant and equipment line item). And then this asset will hopefully lead to income in the future.

The final section is equity. Now I have talked about the financial accounting handbook definitions of the previous two components, but the definition of equity is rather abstract in that is based on a derivative of the previous two definitions. The better way to look at equity is to reckon of it as what is left for the owners of the business if all the assets were liquidated and the liabilities paid off. Equity represents owner, or shareholder, funds that have been invested, or retained, in the business (although this is not the exact definition).

Never forget than any balance sheet simply shows a snapshot in time of what a business:
• “Owns” (assets)
• “Owes” (liabilities)
• “What is left for the owners of the business” (equity)

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Thumbnail Portrait: Photo by Daniel Xavier from Pexels

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