Financial statements are documents that provide insights into a company’s operations. Usually, companies prepare four financial statements. These include the balance sheet, income statement, cash flows statement, and statement of equity. Sometimes, companies may also prepare two or three of these statements. However, the balance sheet and income statement are crucial to them.
Each financial statement within the list has its own purpose and presentation method. Usually, the accounting standards that a company follows will dictate how it must prepare them. In some cases, the jurisdiction where it operates will also provide instructions on the preparation. However, the format and elements within these financial statements remain the same.
Stakeholders must read and analyze every financial statement on its own to get valuable information. These statements have specific formats and classifications that set them apart. From these, the balance sheet is a highly critical financial statement that brings all balances together. It has three classifications which appear as different sections. However, it is crucial to understand what the balance sheet is first.
What is the Balance Sheet?
The balance sheet is a financial statement that includes a list of balances. These balances represent various accounts within a company’s financial system. In some cases, they may also consist of different balances within those systems. The balance sheet summarizes all those balances to provide details about a company’s financial position. Therefore, another name used for it is the statement of financial position.
The balance sheet is a crucial financial statement that ties all account balances together. It also integrates the income statement within a company’s financial position. By doing so, it provides a snapshot of its operations. Unlike other financial statements, the balance sheet does not cover a specific period. Instead, it provides information at a specific point. It is one of the distinguishing features of these statements.
The balance sheet also gets its name by providing an equal or balanced equation. This financial statement uses the accounting equation as a base. Under this equation, a company’s total assets will equal the sum of its total liabilities and equity. The balance sheet categorizes its balances into two sections. The first includes total assets, while the other consist of the sum of total liabilities and equity. In the end, the balances on both sides will be equal.
In essence, the balance sheet provides a snapshot of two aspects of a company’s operations. The first is what it owns, which falls under total assets. In contrast, it also provides a picture of what the company owes. These obligations fall under two categories, liabilities and equity. The former represents what the company owes third parties. On the other hand, the latter is obligations toward shareholders.
Overall, the balance sheet is a financial statement that provides a snapshot of the company’s operations. It includes a list of balances that relate to the financial accounts. In other words, it gives an overview of the state of finances for a company at a specific time. The balance sheet follows the accounting equation.
What are the three classifications on a Balance Sheet?
As mentioned, the balance sheet has two sections. The first covers total assets, while the other includes the total liabilities and equity. These areas also show the three classifications on the balance sheet. All balances on this statement fall within those areas. Overall, the three classifications on a balance sheet include the following.
Assets:
An asset is a resource that a company owns or controls with a future economic value. In essence, these resources give rise to a future inflow of economic benefits. For companies, these economic benefits help in the generation of revenues. Usually, these revenues come from the use of the asset. In some cases, however, it may also generate through the disposal of the underlying resource.
For companies, assets represent economic resources that can help generate revenues. Sometimes, these revenues may come directly from the assets, while they may also be indirect. Similarly, companies have a legal right to own or control those resources. Some examples of assets include inventories, fixed assets, cash and cash equivalents, accounts receivable, etc.
Within the balance sheet, assets may also constitute two categories, including current and non-current. This classification exists based on how long the company expects to use the resource. Under accounting standards, any assets that last less than 12 months fall under current assets. In contrast, other resources that don’t meet this definition will be non-current.
Overall, the asset classification on a balance sheet includes resources owned or controlled by companies. This classification may consist of short- or long-term assets. The short-term ones fall under current assets, while the remaining ones go under non-current assets. Usually, assets are the first classification within the balance sheet.
Liabilities:
In accounting, liabilities are the opposite of assets. They represent the obligations that companies gather from past operations. These obligations cause outflows of economic benefits in the future. In essence, liabilities represent amounts owed to third parties. Once the company settles them in the future, they will no longer be an obligation.
Liabilities are also a source of finance used to fund operations. In some cases, they may generate from a company’s operations. In others situations, companies may also accumulate them from other parties. Either way, companies must settle these obligations in the future. In most cases, it includes cash repayments. However, it may also involve compensation through other sources.
Like assets, liabilities may fall under two classifications on the balance sheet. These classifications include non-current and current liabilities. Any obligations that a company expects to settle within 12 months will fall under the former category. In contrast, those that will continue after a year will come under non-current liabilities on the balance sheet.
Overall, the liabilities classification on a balance sheet includes obligations from past operations. These obligations result in outflows of economic benefits. Therefore, liabilities are essentially the opposite of assets. In most cases, these obligations include short-term debts, accounts payable, accrued expenses, tax payable, etc. They are a vital aspect of a company since they represent finance for operations.
Equity:
In accounting, equity is the residual interest after deducting a company’s liabilities from its assets. Therefore, it is crucial to understand what those components of the balance sheet are first. In essence, equity is the shareholders’ claim to a company’s assets. However, this claim is only valid when the company liquidates.
In the balance sheet, the “Shareholders’ Equity” heading includes equity. Usually, it consists of balances such as share capital, share premium, retained earnings, etc. In some cases, equity consists of reserves that companies generate from accounting activities. However, some of these reserves may not be distributable among shareholders.
Equity is a highly critical classification on a balance sheet. In essence, it shows how much a company owes to its shareholders. Therefore, it is similar to liabilities since it represents an obligation. As mentioned, however, this obligation only applies if the company liquidates. Unlike assets and liabilities, equity does not include current and non-current portions.
Overall, equity is the classification on a balance sheet relating to shareholders. It is the residual interest in a company after deducting its liabilities from its assets. Along with liabilities, equity forms the second section of the balance sheet. This section represents the shareholders’ claim to assets if it liquidates.
Conclusion
The balance sheet is a financial statement that shows a list of balances. These balances relate to the accounts that are a part of a company’s financial statement. Overall, the three classifications on a balance sheet include assets, liabilities, and equity. Each of these components represents a different part of a company’s operations.
