The Balance Sheet: A dive into the fundamentals.
The balance sheet or the statement of financial position is used to see the current standing of the business. Think of it this way, it's like going into a room and taking a picture, when you develop that image, you see everything in the room exactly as it was when you took that picture. This is precisely what a balance sheet is, it tells you the current position of the business, that is why it is presented as “balance sheet AS AT the end of a period”, showing the exact position of everything at that particular point in time—the end of the period.
That being said, let's discuss the three elements of a balance sheet. They are the assets, the liabilities and the equity as shown in the equation below; Assets = Liability + Equity.
This is commonly referred to as the accounting equation A = L + E.
Assets: Assets are economic resources arising as a result of past actions from which future economic benefits are expected to flow into the company. What we are trying to say here is that assets are the balance sheet items that are owned by the company, and because they are owned by the company, the company will reap benefits in the future. Examples of assets are your building, machines, furniture, patents and licenses. The ones you can physically see and touch are tangible while the ones you can't see and touch are intangible.
They are typically divided into long term assets and short term assets. The difference is in what I would call the holding periods, that is, short term assets are expected to last or be held for not more than 12 months, a company may get a drilling license for 6-9 months, this is an example of a short term asset. Long term assets are expected to last for more than 12 months, like your tables and chairs, computers and machines etc.
Liabilities are the balance sheet items that are owed by the company. Just like the assets, they are divided into short term; they need to be repaid under a 12 months period. They are usually an overdraft and money owed to suppliers, then long term liabilities; these are due in over 12 months and are long term credits.
Equity shows the net financial standing of the company, that is, the difference between what the company owns and owes. Remember this equation A = L + E?
It can also be rewritten as E = A - L. Essentially, this equation shows that if you subtract what the company owes (Liabilities) from what it owns (Assets) what is left is for the shareholders or the owners of the business (Equity).
An important thing to note is that the balance sheet does not account for the future income, hence, it may not be fair to assume that equity is the fair value of the business.
In another article, I would describe the key subtopics in the balance sheet, but at the moment, what we have talked about today is sufficient to give you a solid background into what a balance sheet is and does.
