What is a balance sheet?

A balance sheet, also known as the statement of financial position, is a fundamental financial statement in bookkeeping and accounting. It provides a snapshot of a company’s financial position at a specific point in time, typically at the end of an accounting period, such as the end of a fiscal year or a quarter. The balance sheet is one of the three main financial statements, along with the income statement (profit and loss statement) and the cash flow statement, and it plays a crucial role in assessing a company’s financial health.

The balance sheet is structured around the fundamental accounting equation:

Assets = Liabilities + Equity

Here’s what each component of the balance sheet represents:

1. Assets: Assets represent the economic resources owned or controlled by the company that have measurable value and the potential to provide future economic benefits. Assets are typically classified into two main categories on the balance sheet:
   • Current Assets: Assets expected to be converted into cash or used up within one year or one operating cycle, whichever is longer. Examples include cash, accounts receivable, inventory, and prepaid expenses.
   • Non-Current Assets (Long-Term Assets): Assets expected to provide economic benefits beyond one year. Examples include property, plant, and equipment (PPE), intangible assets, long-term investments, and other non-current assets.
2. Liabilities: Liabilities are obligations or debts that the company owes to external parties. Like assets, liabilities are classified into two main categories:
   • Current Liabilities: Liabilities that are expected to be settled within one year or one operating cycle. Examples include accounts payable, short-term loans, and accrued expenses.
   • Non-Current Liabilities (Long-Term Liabilities): Obligations that are due beyond one year. Examples include long-term loans, deferred tax liabilities, and other non-current liabilities.
3. Equity: Equity represents the residual interest in the company’s assets after deducting its liabilities. It is often referred to as shareholders’ equity for corporations and owner’s equity for sole proprietorships or partnerships. Equity includes:
   • Common Stock: The value of shares issued to shareholders.
   • Retained Earnings: Accumulated profits or losses retained by the company over time, including net income from prior periods and adjustments.

The balance sheet provides a clear picture of a company’s financial position by showing how its assets are financed—either through liabilities or equity. When the balance sheet equation is in balance (i.e., when assets equal liabilities plus equity), it indicates that the company’s resources are effectively accounted for.

Analyzing the balance sheet allows stakeholders, including investors, creditors, and management, to assess a company’s liquidity, solvency, and overall financial stability. It also helps in evaluating the company’s ability to meet short-term and long-term obligations, make investment decisions, and understand its capital structure.