Question

DB Post: What is balance sheet? What are the major components of the statement? What are the logic links between these components? Illustrate your points with examples.

Answer 1

Balance Sheet is a statement used to determine the financial strength and weakness of a business. It lists everything a company owns and everything a company owes at a specific point in time. For example, an existing business may develop a balance sheet on July 8, 200X in order to see what it owns and owes on that specific date. The same company may develop another balance sheet on August 20, 200X to view the items it owns and the money it owes on that date. The company then can compare the two Balance Sheets (on July 8 and on August 20) to determine whether their financial position is improving. If, however, you are not an existing business owner but are planning on establishing a business, you will be required to construct annual forecasted balance sheets for three years into the future. This will enable you, as a potential business owner, to estimate the items your business anticipates to own in each of the three years as well as how much your business anticipates to owe in each of the three years. By developing a forecasted annual balance sheet for three years into the future, you and investors will be able to determine if your proposed business provides an opportunity.

Whether you are an existing business owner or an aspiring entrepreneur, it's imperative to fully understand the components and principals of the balance sheet. In this section, we will discuss the components and principals of the balance sheet. The following information will not show you how to develop forecasted balance sheets; this is discussed in the section entitled Developing Your Own Forecasted Financial Statements. Be sure to read this section before attempting to develop your own forecasted balance sheet!!!!! Lets get started.

FOUR COMPONENTS OF THE BALANCE SHEET:

The balance sheet consists of four main components, namely; the Heading, Assets, Liabilities, and Equity. The Heading depicts the name of the company, the name of the statement and the date at which the account balances apply. Assets are items that have economic value to a company. Liabilities are items that have an economic burden on the company - usually items a business owes to other businesses. Equity consists of all the investments made into a company over the years - usually in the form of capital or shareholder's investments and retained earnings. One very important thing to remember about the Balance Sheet is this:

THE ASSETS OF ANY BUSINESS MUST ALWAYS EQUAL THE SUM OF THE BUSINESSES' LIABILITIES AND EQUITY.

ASSETS = LIABILITIES + EQUITY

This is how the Balance Sheet received its name. The Assets balance with the Liabilities and Equity. Lets now separately explain the four major components of the Balance Sheet. To do this we will use the following balance sheet example.

Balance Sheet Example:

The TOY Company

Balance Sheet

As of December 31, 200X

ASSETS:

Current Assets:

Cash $10,122

Accounts Receivable $ 5,000

Prepaid Fire Insurance $ 1,200

Inventory $12,558

Total Current Assets $28,880

Fixed Assets:

Office Equipment (2yr life) $12,500

Less Accumulated Depreciation $ 6,250

Net office Equipment $ 6,250

Building (5 year life) $22,500

Less Accumulated Depreciation $ 2,250

Net Building $20,250

Total Fixed Assets $26,500

TOTAL ASSETS $55,380

LIABILITIES:

Current Liabilities:

Accounts Payable $12,254

Income Taxes Payable $ 5,676

Short-Term Loan Payable $ 5,179

Total Current Liabilities $23,109

Long-Term Liabilities:

Mortgage on Building $19,757

TOTAL LIABILITIES $42,866

EQUITY:

Capital - Donald Sutherland $12,514

TOTAL EQUITY $12,514

TOTAL LIABILITIES & EQUITY $55,380

As you can see the Asset = Liabilities + Equity ($55,380 = $42,459 + $12,921).

Balance Sheet Items and Components:

1. The Heading of the Balance Sheet

2. Balance Sheet Assets

3. Balance Sheet Liabilities

4. Balance Sheet Equity