In order to master accounting theory and practice, it is essential to learn and understand main accounting terms. One of the most important is Balance Sheet, essence of which is described further.
Balance Sheet is one of the three main financial statements, including in addition Income Statement and Cash Flow Statement. This financial statement is a reflection of the basic accounting equation, where Assets=Liabilities+Equity. This means that Balance Sheet includes assets, liabilities and equity and reflects structure of the assets as of particular date together with the structure of the financial means how these assets are being financed, either by the own means, or by the borrowed means.
From the name of this financial statement it is obvious that total value of the assets is equal to total value of liabilities and equity.
Considering the structure of Balance Sheet, this financial statement has to provide specification of the main categories of assets, liabilities and equity in order for the users of it to be able to judge on the financial position of the entity and make adequate decisions. The following items are included:
- Current Assets: items to be consumed in the operations of the business within the period less than one year. Include cash, accounts receivable, inventory
- Long-term Assets: items to be used by the business for the period longer than one year
- Total Assets: sum of current and long-term items
- Current Liabilities: amounts to be paid back to creditors within the period of one year or shorter
- Long-term Liabilities: amounts to be paid back to creditors within the period longer than one year
- Total Liabilities: sum of current and long-term items
- Equity: amounts belonging to the shareholders, including share capital (amounts invested) and retained earnings (amounts earned, but not yet distributed as dividends)
- Total Liabilities & Equity: sum of borrowed and own financial means.
So these items must be included into the Balance Sheet to reflect financial position of the business as of particular date and indicate liquidity, i.e. ability of the business to pay its debts on time.