Expenses are a crucial aspect of any business, and business owners need to keep a keen eye on their expenses to run a successful business. And not just expenses, even the revenue generated needs to be closely monitored in order to make good business decisions.
Early on, small businesses will do this process manually, but with scalability comes the added responsibility of keeping a solid record of these numbers. Balance sheet comes to save the day when businesses begin to lose track of their finances.
Through this blog, we will uncover everything about balance sheets, including the balance sheet format and the Schedule 6 revisions in the MCA compliance.
What is a balance sheet?
Balance sheet is a financial statement that records a company’s assets, liabilities, equity at a given point in time. This financial statement serves as the basis to compute rates of return and evaluate the capital for a given company. Essentially, a balance sheet is meant to represent the overall financial position and condition of an organization in terms of profit, loss after a given period of time.
The balance sheet format is prepared on a similar pattern as of the trade entities. The left column represents liabilities and the right represents assets. Always, the sheet is balanced like so:
Assets = Liability+Capital/Shareholder’s Equity
Here, assets are the resources owned by a company or profit that represents or produces positive economic value. And conversely, liabilities are the pending debts, expenditure, amount that is of negative economic value. The capital is the equity or the amount invested by the shareholders.
Why is a Balance Sheet Important?
A balance sheet represents the financial health of a company. To that effect, it serves a solid purpose for those looking to invest in that company. Investors keenly look at the balance sheet for an entity to figure out how valuable their stock is.
Moreover, a balance sheet is an essential document for any company when dealing with banks, or any other financial matters. The following is a comprehensive list of reasons why balance sheet is prepared:
Balance sheets can be used to keep a track of the financial growth of a company, and create an official record of the same year by year. The graphical growth of any entity can be looked at through their balance sheet format over the years, this is done using a comparative balance sheet format.
When applying for a bank loan, companies are required by banks to produce their balance sheets in order to estimate the financial strength of an entity. It is essential for either the company or whoever is applying on behalf of the company to submit a balance sheet to the bank.
Any financial experts, investors, creditors and stakeholders take into consideration the balance sheet of the company to assess it before partnering with or investing in the entity.
Stakeholders understand the performance and liquidity position of a business or subdivision of a business using its balance sheets. For a parent company with subsidiaries companies, a consolidated balance sheet format is used.
Managers use balance sheets to make better decisions regarding project expansion and to balance unforeseen expenses.
- The credit/debts and/or profit of any organization can be seen from the balance sheet.
Key Components of a Balance Sheet
The balance sheet format takes into consideration three sections, assets section, liabilities section and owner's equity or capital section. These are not variables, and are part of the core balance sheet format.
The balance sheet format for parent companies and subsidiaries can also create an all inclusive balance sheet, using a consolidated balance sheet format. Further, a comparative balance sheet format is used to statistically view the financial growth of a company year after year. The following two sections, assets and liabilities, are the key components of a balance sheet format in accounting:
For the balance sheet format, in the asset section, the elements or resources that have an overall positive effect on finances of the entity are listed. Now, within assets there are generally observed two types of assets, current assets and non-current assets.
The current assets in the balance sheet format are cash, or assets that can be liquified instantly into cash, or are available or valid for a very short period of time. For example, cash reserved to buy resources for a financial year will be considered current assets.
Cash, account receivables, advance payments or prepaid expenses, are all included as current assets. Short term investments that yield results that year, or inventories are also included in current assets in the balance sheet format.
All other assets like long term investments that yield after a period of one year, are viewed as non-current assets in the balance sheet format. One easy way to categorize non-current assets is to look at the time period of returns given by it.
Liabilities are also represented as current and longer term liabilities in the balance sheet format. Liabilities as a whole represents negative financial value, such as debts or obligations that are supposed to be met.
Overall, liabilities will represent loss, or any expenses going outward from the organization. The current liabilities are short term liabilities that are supposed to be taken care of within the year. The non-current or long term liabilities are those that will take over a year to be met fully. For example, rent is an expense that will be considered as a liability.
Owner’s Equity/Capital Section
The owner’s equity section represents the obligation of the business to the owners. This is the same as the partners’ capital amount on the balance sheet format of the company. The value of equity is the contributed capital to the business made by the owner, and the withdrawals also.
For this reason the owner’s equity is a net worth amount. The term owner’s equity is also called “stockholder’s equity”. The owner’s equity section is presented after the liabilities section.
Sample Format of a Balance Sheet
The balance sheet format largely is universally accepted with the three sections of assets, liabilities and owner’s equity. However, there are two ways of presenting the balance sheet format, these two are known as account format, and report format. The account format is divided into left and right sides.
With assets being on the left and liabilities and owner’s equity on the right. This is a pretty standard balance sheet format. Always, for a correctly created balance sheet, the total of the left side is equal to the total of the right side. This is also known as the T-shaped or horizontal format for balance sheet format.
The other format, report format uses a vertical balance sheet format. The assets section is presented at the top and liabilities and the owner’s equity section right below it. Here’s Bharti Airtel’s balance sheet in a consolidated balance sheet format created using the report balance sheet format:
Notice how the liabilities are broken down into current and non-current liabilities. And the total assets are equal to the total liabilities and equity. These two are the standard balance sheet format.
You can use these examples as a balance sheet template for yourself, keeping in mind the fields you may require.
How to Prepare your Balance Sheet
To prepare your balance sheet companies need to compose trial balance, arrange it, discard all expense and revenue accounts and crunch the numbers on the rest of the amounts. Here are all the steps for preparing your balance sheet or statement of financial position, explained:
Step 1. Trial Balance Composition
This is a standard report that includes every general ledger accounts’ ending balance. This can be done by straight away transferring the general ledger’s balance to a spreadsheet.
Step 2. Trial Balance Arrangement
The initial trial balance created in the step one is arranged in the format of the account structure. The entries of the trial balance are to be adjusted to match the records as standardized by the auditors. Because the trial balance is audited, ensure that all the entries are completely recorded.
Step 3. Discard the extras
Once you create the trial balance, it will include terms like expenses, revenue, losses, gains, liabilities, equity and assets. From here you need to retain equity, liabilities, assets and delete the rest. Whatever is deleted usually makes up the income statement.
Step 4. Calculate the Remaining
Everything on the trial sheet is summed up to create the balance sheet The things including in the balance sheet are generally: cash, account receivables, inventory, fixed assets, other assets, payable accounts, accrued liabilities, debts, other liabilities, common stock, retained earnings.
Step 5. Validate the Balance Sheet
The balance sheet is validated using this basic rule: the total assets recorded in the balance sheet is equal to the liabilities and stockholder’s equity accounts. You may also want to take into account your tangible assets and working capital.
Step 6. Balance Sheet Format
Now, you can choose your preferred balance sheet format to create the balance sheet. Report balance sheet format, or account balance sheet format can be used to create the yearly balance sheet. The steps for creating a consolidated balance sheet are discussed further in the blog. The balance sheet format for individuals in excel follows either the report balance sheet format, or account balance sheet format.
Formula for Balance Sheet
The balance sheet format always follows a standard accounting equation:
Assets = Liabilities + Equity
This is the reason it is called a “balance” sheet. It is balanced through the financial obligations, equity and earnings. As a company operates, it will steadily keep on balancing this amount.
The assets here are what any entity will use to keep up its operations as a business, and the liabilities and equity are used to support these assets. When a company is publicly traded, the equity is referred to as shareholder’s equity. The amount of money invested into a company initially plus the retained earnings are the funding for that company.
Now, taking all these factors into consideration, a balance sheet format is prepared. Keep in mind, the above formula is always true for any balance sheet. Any discrepancy here makes the balance sheet invalid.
Consolidation of Balance Sheet
Consolidated balance sheet is created by companies looking to include the financial details of the parent company as well as the subsidiaries.
The consolidated balance sheet format includes both the financial statement and elements of the parent company and the subsidiaries in one single balance sheet format. It is generally created by a parent company for either self created subsidiaries or after acquiring 50% stake in another business or a company.
How to Prepare a Consolidated Balance Sheet?
The consolidated balance sheet format is slightly tricky compared to the usual balance sheet format. First and foremost, there is a slight modification in the assets section. The accurate market value needs to be taken into consideration for the assets of the subsidiaries.
Further, the revenue of the parent company is not included in the balance sheet. Since the subsidiaries make up the total revenue amounting to the same.
Once these small changes are taken care of, the process is pretty much the same. The left column indicated the assets, in case of an account balance sheet format. And the right indicates the liabilities and equity. The numbers are included as total assets, liabilities and equity. And the final total should match that of the balance sheet of the parent company.
The MCA Compliance are a set of requirements issued by the Ministry of Corporate Affairs and are applicable to all companies. Every company is mandated to prepare a profit and loss account and balance sheet as per the given format. Here are the line items that need to be included:
- Current Asset: Cash, Accounts Receivable, Inventory
- Fixed Asset: Equipments, Vehicle, Land
- Intangible Asset: Goodwill
- Current Liability: Accounts Payable, Accrued Expenses, Taxes Payable
- Long Term Liability: Long Term Debt
- Shareholder’s Equity: Capital Stock, Retained Earning
The balance sheet format as per schedule 6 requires liabilities and assets to be classified in terms of current and non-current.
Limitations of a Balance Sheet
The balance sheet format has been designed to create a statement of finance that is standardized across companies. However, it is just a snapshot of the entire situation. And that too very set in time, making it static.
Companies need to create more dynamic financial records like statements of cash flows, and dynamic income statements. These two give a rounder view of the financial situation of a company. Another important thing is the different accounting systems, and the different approaches to it.
Different managers have different ways of dealing with depreciation and inventories and these need to be updated constantly. When a balance sheet has already been finalized, last minute changes can be frustrating.
Balance sheet is one of the foundational financial statements that is mandated by the government. The balance sheet format India is given by the MCA, Ministry of Corporate Affairs. Companies are required to adhere to the updated balance sheet format and create balance sheets in a timely manner.
The balance sheet format is fairly simple once you get a hang of it, so don’t be intimidated by the lengthy balance sheet. Simply follow the steps given above and get right into it and don’t fret too much.
The balance sheet format always follows the balance sheet equation. Keeping that in mind, you can easily create an accurate account of your company’s balance sheet every year.
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