The balance sheet describes the financial situation of a business at a given time. It provides us critical information about the value of the firm’s assets, liabilities and the owner’s equity. The balance sheet of a company shows the assets on one side and the liabilities and owner’s equity on the other side in such a way that both sides balance in accordance with the accounting equation.
Assets = Liabilities + Owner’s Equity
Assets: Assets are what a business owns or what is owed to it. It includes items such as cash, accounts receivable, merchandise to be sold, supplies, equipment, and land. Assets also include intangible items such as patents, franchises, and copyrights.
Liabilities: Liabilities are what the business owes to others. Some examples are payments to be made to suppliers, salaries to employees, taxes to government agencies, rent to landlords, mortgage, and loans and interest payments to financial institutions.
Owner’s equity: Owner’s equity is the money that the owners of the business have put into the business. It also includes the owner’s claim on the assets of the business.
To understand a balance sheet better, let us take a look at the elements of balance sheet of a fictitious company, Innovative Products, Inc. The balance sheet is shown on the next page. As you can see, the balance sheet shows all assets on top, and then all liabilities and shareholder’s equity below the assets. This style of presentation is called report form or vertical presentation. Alternatively, balance sheet can also be presented in a horizontal format in which the assets will be shown on the left side, and liabilities and equity will be shown on the right hand side. In a balance sheet, the total assets will always be equal to the sum of liabilities and shareholder’s equity.