Accounting – Key Elements of a Balance Sheets

The balance sheet is a financial report prepared by accountants to summarize the company’s financial situation. A balance sheet has three elements: Owners equity, liabilities and assets. The statement shows the owners’ equity and liabilities on the left and the assets on the right. It is defined as Assets = owners’ equity + liabilities.

A balance sheet is an important statement to lenders because it is used it to assess the company’s creditworthiness. The financiers could be interested in certain financial ratios like debt-to-equity ratio or debt-to- asset ratio to help them decide whether to invest in the company or not. On the other hand, managers use the statement to decide on the earnings to distribute to the shareholders. The suppliers and investors have an interest in the balance sheet.

Assets

This section shows all the items of tangible value owned by the company. It shows current assets and fixed assets. Cash, account receivables and securities are classified as current assets. Ideally, the current asset side is compared to the current liabilities. It sheds some light on the ability of the firm to pay its short term financial obligations. Current assets can be converted into cash within 12 months, whereas fixed assets would take a longer time before they can be converted into cash. The long term assets are used to operate the business.

Liabilities

Liabilities are divided into current and long term. Long term liabilities are debts that are payable in a period of 2-5 years while short term liabilities are payable within 12 months. Examples of short term liabilities include accounts and notes payable. A business should do away with higher near-term debts because they stifle the growth of the business. Long term loans for building or for buying fixed assets are treated as long term liabilities. The balance of long term liabilities show how leveraged the company is to lenders. If the company is engaged in continued debt payment, it reduces its cash flow and eventually limit the company’s growth.

Owners’ Equity

This is the difference between the company’s assets and liabilities. It represent what the owners of the company would be left with were they to sell the company’s assets and pay all the outstanding debts. It refers to the retained earnings and current year’s earning flowing from the income statement and the share’s paid in capital or the starting price of the shares. Paid in capital refers to the starting price of the shares or the par value of the public limited company shares.

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