All businesses prepare a balance sheet at year-end, and most prepare one every month. The balance sheet is a listing of the company’s assets, liabilities, and owners’ equity. The total of the assets must agree to the total of the liabilities and owners’ equity.
One constant for all balance sheets is that cash is always listed first in the assets section. After cash, the other assets, including notes receivable ,accounts receivable, supplies, fixed assets, and any other assets, are listed in order of liquidity. All of the liabilities are listed, with current liabilities first, followed by long-term liabilities. Some of the most common liabilities are notes payable, accounts payable, and long-term debt. Finally, the owners’ equity assets are listed.
The balance sheet supports the accounting equation: assets equals liabilities plus owners’ equity. Another way of looking at the equation is that assets minus liabilities equals owners’ equity. The balance sheet provides the details to this general equation.
The listing of assets reveals what the business owns. The liabilities and owners’ equity listing reveals how the assets were obtained. The total amount owed to creditors and lenders plus the total amount contributed by the owners equals the total assets of the business.
The definition of an asset is an economic resource owned by a business that is expected to benefit the future operations of a business. There are both tangible assets, which have a physical presence, and intangible assets, which do not. Some examples of physical assets are cash and fixed assets. Some examples of intangible assets are patents, trademarks, copyrights, and goodwill.
The definition of a liability is a debt. A business may have both short-term and long-term liabilities. The difference between the two is that a short-term liability is due to be paid in one year or less.
Owners’ equity is defined as the resources invested in a business by the owners. It is the difference between the assets and the liabilities of the business. This makes sense because the obligations to the creditors of the business legally come before the obligations due to the owners. The owners’ equity comes from both investments by the owners and the net profits of the business. Owners’ equity would be decreased by a net loss of the business, and also by any withdrawals by the owners.
Balance sheets are important to people outside the company as well as to the company itself. A bank considering a loan to the business would be interested in the balance sheet. They would consider the amount and types of assets compared to the amount, types, and payment due dates of the liabilities, since that reflects the company’s ability to pay its debts on time.
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