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What Is a Balance Sheet?
What Is a Balance Sheet?
A balance sheet is an essential financial statement used to determine a company’s assets, liabilities, and equity over a specific period. Also referred to as the statement of financial position , a balance sheet is what a company uses to disclose what it owns and what it owes—represented by a single, fundamental equation:
Assets = Liabilities + Equity
Table of Contents
- The 3 Main Elements of a Balance Sheet
- What Is a Clean Balance Sheet?
- What Is the Purpose of a Balance Sheet?
- Balance Sheet Key Takeaways
The 3 Main Elements of a Balance Sheet
As the name suggests, a balance sheet must always balance to reflect a company’s financial position accurately. A balance sheet’s three core elements are broadly defined as the following:
Assets
Assets are all items of value held by a company. A balance sheet organizes assets in order of their liquidity—how quickly and easily a company can convert the assets into cash.
Assets include short-term and long-term values (also called current and non-current), indicating whether a company means to liquidate them within a specified period or hold them longer.
Assets commonly include a combination of the following:
- Cash equivalents, such as treasury bills and certificates of deposit
- Accounts receivable (AR)—money owed by a company’s customers
- Inventory
- Fixed assets like land, physical structures, and equipment
- Intangible assets like intellectual property (IP) and patents
Liabilities
Liabilities are debts owed by a company in the recorded period. As with assets, a balance sheet classifies liabilities as short-term and long-term. In this case, the term of a liability specifies whether a company means to pay a debt within the given year. Common liabilities owed by companies include:
- Accounts payable
- Wages payable
- Federal and state taxes payable
- Loans
Equity
Equity is often referred to as owner’s equity or shareholder’s equity and is the total value of a company’s assets after deducting the company’s total liabilities.
What Is a Clean Balance Sheet?
A clean balance sheet is error-free, providing a financial record for a set period that is:
- Accurate
- Consistent
- Up-to-date
- Formatted correctly
- Uncluttered
What Is the Purpose of a Balance Sheet?
A balance sheet assesses a business’s health, meaning whether a company is sufficiently liquid or substantially in debt. In this critical role, a balance sheet evaluates how a company operates, whether it’s on a positive trajectory with profits and spending or must make changes for its well-being.
The benefits of transparency and insight help further illustrate what a balance sheet is. For a business to secure capital, a balance sheet can provide a record of its creditworthiness to a bank and other lenders. Investors can view a balance sheet to determine an expected rate of return, while potential investors can use it to assess risk levels when considering an investment.
Financial Ratios
One can use a balance sheet to formulate several commonly-used ratios when evaluating a company’s finances. Three of the most widely used financial ratios are:
Liquidity Ratios
This ratio determines the capability of a business to convert assets into readily available cash.
Solvency Ratios
A solvency ratio helps assess a company’s ability to pay off its debts.
Profitability Ratios
This ratio helps to evaluate a business’s ability to generate income.
Balance Sheet Key Takeaways
A balance sheet must do the following:
- Provide a clear picture of a company’s finances
- Always balance assets, liabilities, and equity perfectly
- Measure financial performance, responsibility, and creditworthiness within a set period
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