Statement of FInancial Position (Balance Sheet)

Statement of Financial Position (Balance Sheet)

What it is

  • The Statement of Financial Position, often called a balance sheet, is a key financial document in a business.
  • This document provides a snapshot of a company’s assets, liabilities and equity at a specific point in time.
  • The balance sheet is used to determine net worth, which is calculated as total assets minus total liabilities.

Components

  • It has three main parts: assets, which are items of value owned by the business; liabilities, which are amounts owed; and equity, also known as capital, which represents the value of an owner’s investment in the business.
  • Assets are typically classified as current and non-current. Current assets are those expected to be turned into cash within a year, like inventory. Non-current assets have a longer life, such as property and equipment.
  • Liabilities are divided into current liabilities, which are due in under a year, and long-term liabilities, which are due more than a year away.
  • Equity includes contributed capital (money invested by owners), retained earnings (profits kept within the business), and other components depending on business type.

How it Works

  • A balance sheet always balances: the total value of assets is equal to the total of liabilities and equity. This is due to the accounting equation: Assets = Liabilities + Equity.
  • The balance sheet is a navigational tool for viewers to understand the company’s financial position.
  • It helps a business to estimate its liquidity, solvency, and investment potential.

Importance

  • The balance sheet is important for decision-making within the business. It can inform strategies and policy choices.
  • Stakeholders use balance sheets to understand the financial health and strength of a business.
  • Balance sheets are necessary for the creation of a complete annual report.

Limitations

  • A balance sheet presents data for one specific date and does not show the fluctuations that occur over time.
  • It may not accurately reflect the current market value of assets and liabilities.
  • The balance sheet may not show all relevant financial data, such as internal factors or industry trends. For instance, the value of a company’s brand is not represented.