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Balance Sheet – Simple Definition & Examples

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Balance Sheet in Simple Words

Balance Sheet is a financial statement showing what a company owns, what this company owes, and what’s left over

A balance sheet (also known as Statement of Financial Position) provides a snapshot of:

  • What a company owns (Asset)
  • What a company owes (Liability)
  • What’s left over or what truly belongs to the owner (Equity)

Purpose of Balance Sheet

As one of the four financial statements, Balance Sheet has the main purposes of 

  • Showing how healthy or strong a company is in managing its assets and liabilities. Let’s consider an Airbnb host with $5 million worth of properties and $2 million in mortgage debt. This results in $3 million of equity, indicating a healthy business with no solvency problem. However, if the host owes $6 million to the banks in mortgages, the situation is concerning because they owe more than what they own and the business is at risk.
  • Showing what makes up a company’s assets and liabilities, revealing a company’s operational approach. For instance, an investor can form an opinion on whether a business holds too much cash instead of investing the cash somewhere else that would generate more return.

Please remember that Balance Sheet does not provide good information on how much profit a company is earning – that’s demonstrated in Income Statement. Balance Sheet shows what a company owns/owes, which is different from its profit. 

Balance Sheet Equation

The balance sheet is governed by a very important fundamental accounting equation, also known as the balance sheet formula: Assets = Liabilities + Equity. (A=L+E, or A=L+SE).

How can we understand this formula? At first glance, it means

What we own (A) = What we owe (L) + What’s left over (E)

But if we re-arrange the order of this formula, it will look like this:

What’s left over (E) = What we own (A) – What we owe (L)

For example: I have $100 in my pocket but I owe my roommate $60, how much is left over, or how much do I truly own? $40. Because $40 (E) = $100 (A) – $60 (L)

So why is it presented or taught in the A=L+E way? Because that’s how Balance Sheet is presented. Every balance sheet must have its total asset equal to the combined total of liability and equity. See below

Balance Sheet Simple Example

Pho my Life Noodle Shop (PML) presented its Balance Sheet as of 12/31/2024:

  • 1st section – Assets: PML owns the following assets: $2,000 Cash, $1,500 worth of furniture, and $2,000 worth of Kitchen equipment. Their total assets are $5,500.
  • 2nd section – Liabilities: PML owes Accounts Payable $300, and accrued expenses $700. The total liabilities are $1,000
  • 3rd section – Equity: PML’s equity consists of $2,000 retained earnings, and $2,500 owner’s investment. The total equity is $4,500.

(Question about what those accounts mean? These links provide a simple explanation of asset, liability, and equity) 

This also simply demonstrates the balance sheet formula, where total assets ($5,500) = Total Liabilities ($1,000) + Equity (4,500). In other words, PML noodle shop owns $5,500, owes $1,000, and therefore they have a $4,500 left over.

Unlike the other three financial statements, Balance Sheet is the only one that presents financial results at a point in time. It is a snapshot of how much a company owns or owes on a specific day, as if someone walked into the noodle shop and took a picture of everything the restaurant owns on the last day of the year. In other words, it doesn’t reflect what the restaurant owned or owed the previous month. The other three financial statements all show activities, or what happened throughout the year, rather than a snapshot at the end of the year.

Quick Q&A

Q: What is Balance Sheet used for?

A: Balance Sheet is used to provide a snapshot of a company’s overall financial health or strength.


 

Q: How is Balance Sheet classified?

A: Balance Sheet is classified into three groups: Assets (including both current/non-current assets), Liabilities (including both current/non-current assets), and Equity. 


 

Q: How is Balance Sheet calculated?

A: Instead of calculating, most accounts are given a value through various valuation methods. For instance, cash is worth its face value (a $50 bill is worth $50), while kitchen equipment can be valued by the market price (If the equipment were sold today, it would be worth $2,000). There is no standard answer to this question, as different accounts are valued differently.


 

Q: Can Balance Sheet be unbalanced?

A: No, Balance Sheet has to be balanced. Assets must equal liabilities plus equity.


 

Q: Can Balance Sheet equity be negative?

A: Yes, Balance Sheet equity would be negative if liabilities are greater than assets.


 

Q: Why Balance Sheet always tally?

A: Because Balance Sheet must follow the accounting principle: Assets = Liabilities + Equity. That’s why Balance Sheet always tallys or is always equal.


 

Q: What’s the other name of Balance Sheet?

A: Balance Sheet is also called Statement of Financial Position, because it reveals whether a company is in a good position to deal with solvency, liquidity, or debt problems. 


 

Q: Are Balance Sheet monthly or yearly?

A: Balance Sheet is usually prepared on a yearly basis. Quarterly Balance Sheet is also required for publicly traded companies where disclosure of quarterly financial results is required. Monthly Balance Sheet is rare.


 

Q: Is Balance Sheet year-to-date?

A: No, Balance Sheet is not year-to-date. It doesn’t cover a time period of activities, unlike the other financial statements. Instead, it takes a snapshot of the company’s assets and liabilities balance on a specific date (usually the last day of the year for the annual Balance Sheet, or the last day of the quarter if it’s a quarterly Balance Sheet). For example, it shows a company has a $50,000 cash balance on 12/31/2024, but didn’t detail how the balance ended up being $50,000 or how long it took the balance to become $50,000 Therefore, it is not technically correct to say the Balance Sheet is year-to-date.


 

Q: What is a Balance Sheet only audit?

A: Not every company has to prepare a full set of audited financial statements to stay compliant. For instance, some lenders would only require an audit of the Balance Sheet to prove the covenant requirement is properly supported. In that case, the company will go through a Balance Sheet only audit. 

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