Although the balance sheet is just as important as the income statement, it is often ignored by entrepreneurs. In order to find out the company’s financial situation, it is extremely important to read and understand the balance sheet. Profit for the year might be good according to the income statement, but the company might heavily in debt. For this reason, there is one number in the balance sheet to which the entrepreneur should pay particular attention to: Equity. Equity is the difference between assets and liabilities.
The balance sheet shows the assets and liabilities of a company at a given time as well as the financial situation of the company at the end of the financial year. The basic principle of a balance sheet is simple, it’s balanced. The balance sheet consists of two parts: Assets and liabilities. Assets are everything owned by the company whereas various stakeholders are liabilities. Therefore the wealth half of the balance sheet is referred to as assets while the financial half of the balance sheet is referred to as liabilities. The total of these halves is equal and therefore they are balanced.
The assets of the company can be financed either through personal funding or credit. Personal funding is referred to as ‘equity’ and credit is referred to as ‘liability’. These are the main items on the liabilities side. On the liabilities side, one can also find ‘untaxed’ and ‘mandatory provisions’. These items arise from certain balance sheet arrangements. However, these items are quite rare in the smaller companies.
Why are the halves of the balance sheet equal?
If a company has a certain amount of money, it has had to acquire that same amount from somewhere.