Back to: Financial Accounting
Hello again!
This week, we’re turning our focus to the Balance Sheet, also known as the Statement of Financial Position. This statement provides a snapshot of a business’s financial health at a specific point in time. Unlike the Income Statement, which looks at performance over a period, the Balance Sheet is a static picture.
What is Statement of Financial Position?
The Balance Sheet shows the relationship between Assets, Liabilities, and Equity. It’s based on the fundamental Accounting Equation:
Assets = Liabilities + Owner’s Equity
Assets are everything the business owns (e.g., cash, buildings, equipment).
Liabilities are what the business owes (e.g., loans, accounts payable).
Equity represents the owner’s interest in the business (also called Shareholders’ Equity for corporations).
The Balance Sheet is divided into two main sections:
Assets (on the left)
Liabilities and Equity (on the right)
Both sides must always balance—hence the term “Balance Sheet”.
Structure of the Balance Sheet
Assets
Assets are divided into two categories:
Current Assets
These are assets expected to be converted into cash or used up within one year. Examples include cash, accounts receivable, and inventory.
Non-Current Assets
These are long-term investments, including property, plant, equipment, and intangible assets like patents or goodwill.
Liabilities
Liabilities are also divided into:
Current Liabilities
These are debts the company must settle within one year, such as accounts payable, short-term loans, or accrued expenses.
Non-Current Liabilities
These are obligations due beyond one year, like long-term loans or bonds payable.
Equity
Equity represents the residual interest in the assets of the company after liabilities are deducted. It includes:
Share Capital
The amount invested by the owners or shareholders.
Retained Earnings
Profits that are kept in the business rather than paid out as dividends. These accumulate over time.
The Balance Sheet Equation
The Balance Sheet must always balance. This means:
Assets = Liabilities + Equity
Let’s break it down using an example:
Example of a Balance Sheet
ABC Ltd – Balance Sheet as at 31 December
Assets
Amount (N)
Liabilities & Equity
Amount (£)
Current Assets
50,000
Current Liabilities
20,000
Cash
20,000
Accounts Payable
10,000
Accounts Receivable
15,000
Short-term Loans
10,000
Inventory
15,000
Non-Current Liabilities
30,000
Non-Current Assets
80,000
Long-term Loan
30,000
Property, Plant, Equipment
60,000
Equity
80,000
Intangible Assets
20,000
Share Capital
50,000
In this example, ABC Ltd has total assets of N130,000. This is perfectly balanced with its liabilities and equity, which also total N130,000.
Why the Balance Sheet Matters
The Balance Sheet is important because it gives insight into the financial stability of a business. If a business has more assets than liabilities, it is in a strong financial position. On the other hand, if liabilities outweigh assets, the business may face financial difficulties.
Retained Earnings
30,000
Total Assets
130,000
Total Liabilities & Equity
130,000