Balance Sheet Method

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A balance sheet is a financial statement that depicts the exact financial position of a business at a specific time. Once a balance sheet has been prepared, it shows a detailed presentation of the assets, liabilities and owner's equity or capital of a company. The balance sheet is cumulative in nature in that it reports the results of all the financial activities of the business since its formation.

The Purpose

  • A balance sheet is like a financial snapshot of what a business has on-hand and what the business owes. Business owners can use the results of a balance sheet to get a quick handle on the financial strengths and capabilities of the company. When considering whether to extend credit, vendors, banks and investors will always ask to see both a company's balance statement and income statement.

The Equation

  • The accounting equation used to prepare a balance sheet is: Total assets = Liabilities + owner's equity. The reason that this financial statement is called a balance sheet is because, ideally, the desired result of the equation is to have the total value of the business's assets be in agreement with -- or equal to -- the total of the business's liabilities and owner's equity or capital.

Identifying Assets

  • The "total assets" figure in the balance sheet equation represents the dollar value of both the short and long-term assets of the business. Typically defined as those assets of the company that could quickly be converted to cash, short-term assets include cash on hand, checking or money market accounts, and accounts receivables. Long-term assets are defined as anything used for the business such as office equipment, machinery, vehicles or real estate that would likely take much longer to convert into cash.

Identifying Liabilities & Equity

  • The "liabilities + owner's equity" is the part of the balance equation that must ultimately equal the dollar value of the "assets." The liabilities refer to the sum total of all long and short-term debts and monies that are owed by the business to outside creditors, vendors and banks. Also sometimes referred to as capital or stockholder's equity, the owner's equity is composed of the initial investment amount made into the business plus any money that was specifically retained to be reinvested back in the business.

References

  • Photo Credit John Foxx/Stockbyte/Getty Images
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