Understanding Balance Sheets


Dividends balance sheet definition is dividends that have been authorized for payment but have not yet been issued. Prepaid expenses represent the value that has already been paid for, such as insurance, advertising contracts, or rent. Balance sheets should also be compared with those of other businesses in the same industry since different industries have unique approaches to financing.

What is a balance sheet and what is its purpose?

A balance sheet is a financial statement that summarizes the assets, liabilities, and equity of a business at a particular point in time. Its purpose is to provide a snapshot of the financial condition of a business, showing the resources it has available to generate profits, how it is funded and its overall net worth.

Identifiable intangible assets include patents, licenses, and secret formulas. Inventory includes amounts for raw materials, work-in-progress goods, and finished goods. The company uses this account when it reports sales of goods, generally under cost of goods sold in the income statement. This account includes the balance of all sales revenue still on credit, net of any allowances for doubtful accounts .

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These financial ratios include liquidity ratios like the current ratio using working capital components and the more stringent acid test ratio that excludes inventory from the calculation. Companies compute their return on assets , equity , or investment to measure performance. A company’s balance sheet includes everything that the company owns and everything that it owes—all of its assets and liabilities, in other words. It also shows the owners’ or shareholders’ equity in the company, which is equal to the difference between its assets and liabilities.

It’s usually thought of as the second most important financial statement. A balance sheet, at its core, shows the liquidity and the theoretical value of the business. A single balance sheet doesn’t tell you how a company’s financial position has changed over time, which can provide a better indication of the company’s future prospects. To determine that, you need to examine balance sheets from several different periods. Some companies facilitate this when they report their balance sheet by including comparisons with earlier balance sheets.

balance sheet | Business English

Accountants and corporate finance teams are responsible for making balance sheets and other financial statements like cash flow statements. However, accountants and other financial team members also use these sheets to quickly calculate company performance metrics, like the current ratio. The balance sheet is used for financial analysis by applying ratios using amounts from the balance sheet and income statement.


For example, before considering whether to offer credit terms, a supplier needs to know how the buyer stands financially. If a company is public, public accountants must look over balance sheets and perform external audits. Furthermore, public companies have to prepare their balance sheets by following the GAAP. Current liabilities include rent, utilities, taxes, current payments toward long-term debts, interest payments, and payroll. This balance sheet formula forms the basis of the statement which is also known as the accounting equation. It’s a good idea to have an accountant do your first balance sheet, particularly if you’re new to business accounting.

Limitations of Balance Sheets

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Within each section, the assets and liabilities sections of the balance sheet are organized by how current the account is. So for the asset side, the accounts are classified typically from most liquid to least liquid. For the liabilities side, the accounts are organized from short- to long-term borrowings and other obligations. Public companies, on the other hand, are required to obtain external audits by public accountants, and must also ensure that their books are kept to a much higher standard. The financial statement only captures the financial position of a company on a specific day. Looking at a single balance sheet by itself may make it difficult to extract whether a company is performing well.

How Do You Read a Balance Sheet?

Comparing debt to equity and debt to total capital are common ways of assessing leverage on the balance sheet. Yes, the balance sheet will always balance since the entry for shareholders’ equity will always be the remainder or difference between a company’s total assets and its total liabilities. If a company’s assets are worth more than its liabilities, the result is positive net equity.