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What is a balance sheet?
The balance sheet is how a business records its financial information. By writing down the values of everything the business owes and owns, one can determine how much the business is worth and allow its owner or shareholders to make better business decisions.
Balance sheets can quickly tell a business owner how much her business is worth over a specific period of time, usually a year. That’s because they’re a complete record of the business’s finances.
The convention varies among different countries and accounting standards, but, in the US, balance sheets are formatted with two columns: assets on the left, liabilities and owner’s equity on the right. The balance sheet is a summary of these three variables, and can be expressed with the equation Assets = Liabilities + Owner’s Equity.
Assets are what the company owns that generate revenue. These can be fixed, or tangible, assets like equipment and real estate, which are put to work for long periods of time, or current assets, which must be consumed to generate revenue, like accounts receivable and inventory.
Liabilities are what the company owes. That means any debt the company has accrued, wages and pensions it needs to pay, or other operational expenses.
Owner’s equity, or shareholder’s equity, is usually recorded along with liabilities on the right side of the balance sheet. Owner’s equity is higher when the value of the assets is higher, and lower when the value of the assets is exceeded by the business’s liabilities, as governed by the formula Assets – Liabilities = Owner’s Equity.
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Balance sheet example
Scooby Snacks Inc., the makers of a brand of dog treats marketed and sold to one single dog, needs to calculate how the business is doing. The company account draws up a balance sheet. On the asset side, Scooby Snacks lists its oven, the treat ingredients, the inventory of treats, and accounts receivable for orders made by a gang of unemployed hippies, for a total of $1,200 in assets. On the liabilities side, it lists debt owed on a small-business loan, which equals $500. Underneath that, one can read that company’s owner’s equity is $700.