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Financial Statements – What Is a Balance Sheet?
Financial statements describe the final results of transactions between a particular organization and other companies and individuals. Transactions include sales, purchases and general cash flows. There are several types of financial statements, including the balance sheet, income statement, statement of cash flows, and statement of changes in owner’s equity. This article will examine one of the most important financial statements, the balance sheet.
A balance sheet is a statement that describes the financial position of an entity at a specific point in time, usually at the end of an accounting period. It shows the organization’s assets, liabilities and owners’ equity.
The balance equation is as follows,
Assets = Liabilities + Owners’ Equity.
There are two sides of the equation that balance, hence why the statement is called a balance sheet.
Assets are financial benefits that will be obtained and controlled by an organization as a result of past transactions. Assets are tangible; They include cash, accounts receivable, inventory and equipment. Assets can be divided into current and long term. Current assets, such as cash, and accounts receivable, are assets that can be converted into cash within one year or provide benefits to the company. On the other hand, long-term assets, which may include land, inventory, and equipment, are paid for and will benefit the company over an extended period of time. Accumulated depreciation is used on the balance sheet to explain how the cost of long-term assets is “used up” during the process of running a business. The cost is spread over the life of the asset. For example, a piece of machinery costs $50,000, and the machine has a useful life of 20 years, so accumulated depreciation for the equipment in the first year is $2,500.
A liability can be defined as an amount owed to another entity, such as the transfer of property or services required to be provided. Liabilities are also made up of current and long term. Current liabilities are those that will be paid within one year, including accounts payable, notes payable, current maturities of long-term debt, and payroll taxes. A long-term loan is one that is repaid over an extended period of time.
Owner’s equity, also called net assets, is the amount the owners of the organization own after deducting liabilities. Some examples of owner’s equity include common stock, excess money in capital, and retained earnings. Common stock is issued as an investment in a business. For example, in a corporation, stockholders are the ultimate owners, claiming all assets after liabilities and preferred stock claims are satisfied. Additional paid in capital is defined as the remaining amount paid by the investor over the stated value of the shares sold. Finally, retained earnings are net earnings that are not distributed to owners or the organization as dividends.
So, what is the purpose of a balance sheet? First, business owners use the balance sheet to analyze the strengths and capabilities of their business. For example, is the business ready to expand? Or, should the business take immediate steps to strengthen cash reserves? Also, balance sheets describe trends, especially in the areas of accounts receivable and accounts payable. For example, there is a loan in the amount due and there is a loan received in a reasonable time. Finally, the balance sheet is scrutinized by banks, investors and vendors to determine how much credit they will extend to the organization.
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