• How-to

As an owner of a new business, your revenue will increase and so will the demand on your accounting system. This includes profit and loss statements and cash flow statements, among others. This is where maintaining a balancesheet will be essential to your business. The balancesheet shall summarize your company’s assets, liabilities and shareholder’s equity and give investors an idea as to what the company owns and owes and how much have shareholders invested in the company.

Roughly, a balancesheet has two sections— left and right. On the left hand side are assets or things that are positive for the company
and on the right hand side are liabilities or equity. At the end, assets have to be equal to liabilities of equity. This would mean your accounts are balanced.

Assets are something which can be converted into cash or will be of economic benefit in the future. The assets for your business would be the money in your bank in the form of savings, money owed to your company, bonds and assets like car, land building and inventory. Assets always mean positive and portray what a business is worth.

Liabilities are exact opposites of assets. Liability would be the amount payable or money that your business owes to someone else. The sources of capital are lenders and shareholders. For example, if a bank gives the company a loan of Rs.900 crore of which Rs.300 crore is due soon, this would fall under current liabilities. The amount of Rs.600 crore would then be categorized as non-current liability of a long-term debt.

A company would have shareholder (s) and if they contribute Rs.100 crore in cash and some initial inventory worth Rs.400 crore to get the company started, this would mean the company has Rs.500 crore under current assets. If the company uses the rest of the debt to buy plant and machinery, which are of use in the long term, this would fall under non-current assets.

The balancesheet would now have current assets of Rs.500 crore and non-current assets of Rs.500 crore, making assets side stand at Rs.1,000 crore. The amount is to benefit the company, can be converted in to cash and/or is of future benefit to the company. On the other hand, we have claims on those assets as liabilities. This would include Rs.900 crore by the debt holders, who have the first claim, and shareholders, who have a residual claim of Rs.100 crore. This means the liability side stands at Rs. 1,000 crore, which equals the balance on the assets side. The basic premise of a balancesheet is that Assets = Equity + Liabilities and Equity = Assets – Liabilities. This means if we sold of all the assets and paid of all the liabilities, the money left would be for the shareholders.

In our current example, if the values of current assets drop to Rs.400 crore, with debt of Rs.900 crore, the equity of shareholders is completely wiped out and they are left with nothing. However, if the value of current assets (real estate for example) becomes Rs. 600 crore, with a debt of Rs.900 crore, the value for shareholders will increase to Rs.200 crore.

Order in a balancesheet is mainly in terms of liquidity which puts cash in hand on the top, followed by current assets. Similarly, on the liability side, the current liabilities come first followed by debt and shareholdings. Balancesheet follows mixed model, which is a combination of historical cost and fair value. In our example, the non-current assets will include real estate. As time passes, their value would only increase. However, the balancesheet would not include the current value of the assets. Thus, a balancesheet reflects mainly a book value of an item and not its fair value.

A balancesheet is a snap shot of the financial position of a company at a point in time. The balancesheet also helps an analyst perform ratio analysis. In this case, if we take current assets and divide it by current liabilities, one would get a snapshot of the liquidity position of a company.

©Entrepreneur October 2011

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assets, balancesheet, business, company, liabilities, Pranbihanga Borpuzari