The balance sheet, sometimes referred to as a statement of financial position, reports on the financial condition of your business at a specific point in time (i.e., as at December 31, 2015). It shows what you own (assets), owe (liabilities) and what’s left over (equity).
The balance sheet consists of two sections that equal each other. Assets = Liabilities + Owner’s Equity. Think of assets as what your business uses to operate and liabilities and equity as two sources that support these assets.
Assets are items that provide future benefit and are categorized as current and long-term (or non-current); current means one year or less. Current assets are cash, cash equivalents (highly liquid investments) and other items that can easily can be converted into cash (accounts receivable, inventory, prepaid expenses). Long-term assets are those which are not turned into cash easily and/or have a lifespan of more than one year. This category of assets includes furniture & equipment, computers, leasehold improvement as well as intangible assets, such as goodwill, patents, copyright. Depreciation is calculated and deducted from these assets and represents the cost of the asset over its useful life.
Liabilities represent amounts your business owes. Like assets, they can be both current and long-term. Current liabilities are the company’s liabilities that will come due, or must be paid, within one year. This includes items such as accounts payable and the current portion of longer-term borrowings. Long-term liabilities are debts and other non-debt financial obligations, which are due at least one year from the date of the balance sheet.
Owner’s equity is the amount of money you initially invested into the company plus any retained earnings; it represents a source of funding for the business. Retained earnings is your business’s cumulative net income less any dividends paid (in the case of a corporation). In general, a large retained earnings balance implies a financially strong company however it’s important to consider the age of the company (an older company will have had more time to accumulate retained earnings) and dividend policy (a company that regularly issues dividends will have lower retained earnings).
The balance sheet provides you with valuable information on the financial condition of your business such as your ability to meet financial obligations; are current assets greater than current liabilities? The balance sheet can also be used to calculate some key financial ratios such as working capital and debt-equity which provide further insight into financial strength of your business.