The balance sheet shows the health of a business from day one to the date on the balance sheet. So, unlike the income statement, which is for a specific time period (month, quarter, year) the balance sheet is all inclusive time wise.
Accounting is based upon a double entry system - for every debit there must be a credit. The net effect is zero which results in the balancing of the books. The proof of this balancing act is shown in the balance sheet when Assets = Liabilities + Equity.
Looking at the balance sheet shown below you can immediately tell many things about this business:
- The type of entity is a sole proprietorship. There are two clues to this fact - the business name shown on the account heading - ABC Retail Shop as opposed to ABC Retail Shop, Inc. which would be a proper designation for a corporation and the fact that Owner's Equity is shown in the Equity section of the balance sheet. A corporation would have Stock and Retained Earnings. A partnership would have an entirely different equity presentation.
- The balance sheet shows an accounts receivable and an accounts payable. This tells me that the business operates on the accrual method of accounting rather than the cash method of accounting.
- And since the business has a merchandise inventory it is a merchandising type of business such as a retail shop rather than a service or manufacturing business.
- Assets = Liabilities + Owner's Equity - this balance sheet is indeed in balance.
Ok - check out the balance sheet. Even if you have no knowledge of accounting what immediately strikes you about this business?
At face value it does appear to be a healthy business in growth mode.
Cash is double short term liabilities. Long term debt, while high, more than likely is related to the plant and equipment of $252,000 and appears to be reasonable. Finally Owner's Equity is shown as a positive figure on the balance sheet which indicates this business has overall net income rather than net loss.
ABC Retail Shop
Balance Sheet
12/31/20XX
| Assets: | Liabilities & Equity: | ||||
| Current Assets: | Current Liabilities | ||||
| Cash | 96,000 | Accounts Payable | 45,000 | ||
| Accounts Receivable | 60,000 | ||||
| Merchandise Inventory | 132,000 | ||||
| Total Current Assets: | 288,000 | Total Current Liabilities | 45,000 | ||
| Long Term Assets: | Long Term Liabilities: | ||||
| Plant & Equipment | 252,000 | Long Term Debt | 150,000 | ||
| less: | |||||
| accumulated depreciation | -108,000 | Owners Equity | 237,000 | ||
| Total Assets | 432,000 | Total Liabilities & Equity | 432,000 | ||
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Accounting and Financial Fundamentals for Nonfinancial Executives
