The Balance sheet – Importance, benefits and functions of the Balance Sheet

“There are three types of assets on the personal balance sheet: financial capital, human capital & social capital. Make sure you invest and are properly diversified across all three of them, especially when you are young.” –  Professor Moshe A. Milevsky-  Schulich School of Business

A balance sheet may be simply defined as a statement showing the assets, liabilities and capital of a company or institution at a particular time.

Having a basic understanding about the balance sheet is important if you want to know the financial health of your company. Balance sheet is of great importance to provide various benefits to the users. One of the most important benefits that is attained through balance sheet is that the correct financial position of a business entity can be ascertained, while it is also helpful to provide the related information through which it can be determined how much a business is worth. On the one hand, providing the information to the users as to how business’s finances are being managed, it provides the information that reveals the overall health of the business on the other. Thus the balance sheet is said to be like a thermometer that provides a reading on the health of the business.

Balance sheet provides the information which is useful for us to consider about the financial risks related  to the business, so that the necessary measures can be taken on time. Besides,  as regards liquidity, it aids greatly to determine whether or not adequate cash is available to meet the operating needs. It also enables the concerned to adjust with the circumstances if they arise. Moreover,  helping the users in decision making process, it facilitates them in determining if the sufficient funds can be provided for the future requirements.  Thus, it helps the business management to increase the profitability and the future wealth.

As stated above a balance sheet is a statement showing the assets and liabilities of a company or institution at a particular time. In a broader sense, it can be defined as a statement that encompasses the assets, liabilities, and capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period. Unlike the income statement which is like a movie of the operational results over a period of time, a balance sheet is a snapshot of the financial condition of the firm on a particular date.

The reason why a balance sheet is often described as a snapshot or a photo of the company on a specific date is that it captures the financial position of the firm and reveals a company’s assets, liabilities and owners’ equity (net worth) having been summarized. The balance sheet, also referred to as a statement of financial position, displays what a business owns and owes, while it shows what a business is worth at one point in time.

Regardless of the size of the business, accounting is a vitally important accompaniment to a business. And an accurate accounting system is a key to many aspects of the business. What we get from the definition of accounting is that it acts as a steward to the company owners and other interested parties in a business and thus it has a custodial role to play. As regards the balance, it does fulfill this function, as it provides a true and fair view of the state of affairs of a business firm showing the assets owned by the firm as well as the claims against them.

Another important function which is served by the balance sheet is that it provides the information about the liquidity position of the firm. At this stage, it is important to mention what liquidity is. In accounting, liquidity (or accounting liquidity) is a measure of the ability of a debtor to pay their debts as and when they fall due. It is usually expressed as a ratio or a percentage of current liabilities. Liquidity is the ability to pay short-term obligations. One important aspect which is to be noted with regard to the liquidity position of a business is that the benefits of greater liquidity are substantial. Hence, the greater will be the liquidity, the lesser will be the risk of liquidity position of the firm and vice versa. It thus this function of balance sheet is helpful for providing the information related to the liquidity position of a business with which it can be determined that whether or not assets can be converted in to cash quickly and also the security can be bought and sold without affecting the asset’s price.

While the liquidity is important for a business to thrive, Solvency is essential to staying in business. In this way, both liquidity and solvency are equally important to a business. Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-term financial obligations and to accomplish long-term expansion and growth. A good sign of a healthy company is that it is both solvent and possesses adequate liquidity. In view of the fact that determining the solvency of the firm is necessary, the balance sheet serves this function allowing its intended users to judge the business’s solvency accurately.

Take a look at Professional Presentations

Written by:
K. A. Fareed (Fareed Siddiqui)
Writer, Trainer, Author, Blogger, Software Developer
BBA, MBA-Finance, MPhil-Financial Management, (MSc-Software Engineering)
(PhD-Management)
MA-English, MPhil-English
Post Graduate Diploma in Computer Applications and Programming
Certificate course in English language proficiency
Level 1 – Leadership and Management ILM – UK
Pursuing CMA-USA
Individual Member of Institute of Management Consultants of India

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