To understand the financial position of your business at a specific point in time, you must look at the balance sheet, together with the Profit and Loss Statement and the Statement of Cash Flow. Together, these reports provide a complete understanding of your business.
The balance sheet has three sections: assets, liabilities and equity.
What Are Assets?
Assets are things and resources that a company owns. They have current and future value and are usually measured in currency. Assets may be subdivided on the balance sheet into categories such as bank accounts, current assets (receivable within one year), fixed assets, work in progress, inventory, non-current (or long-term) assets, intangible assets and prepayments. The items could include accounts receivable (trade debtors), supplier deposits or bonds, stock on hand, equipment, vehicles, properties, investments, and intellectual property.
What Are Liabilities?
Liabilities are amounts owed to suppliers and creditors for goods or services already received. Liabilities may also include payments received in advance for future services yet to be provided by the business.
Liabilities are generally subdivided into current (payable within one year) and non-current liabilities. These include accounts payable (trade creditors), payroll obligations (salaries, taxes, superannuation), interest, customer deposits received, warranties and loans.
What Is Equity?
Equity includes owner funds contributed, drawings, retained earnings and stocks. The value of the equity equals assets minus liabilities.
Transactions that affect profit and loss accounts also affect balance sheet accounts. For example, providing a service increases the accounts receivable balance, which therefore increases the equity.
The Balance Sheet Equation
The balance sheet must always balance! Asset value = liabilities + equity.
For example, if you buy a new vehicle for the business at, say $70,000, having paid a $15,000 deposit and taking out a $55,000 loan, the value of fixed assets increases by $70k, but the bank asset value decreases by the $15k deposit paid. The value of liabilities increases by a $55k loan, thus leaving the balance sheet balanced on both sides of the equation.
The balance sheet equation shows you how much money you would have left over if you paid all your bills and debts and sold all your assets on a given date. This amount is the Owner’s Equity.
Note that the balance sheet equity total is not necessarily how much the business is worth at market value. Business value is calculated on the balance sheet figures and takes many other factors into account.
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