How does a balance sheet balance?

A balance sheet matches net assets (total assets minus total liabilities) on the one hand against equity on the other. Here's how.

The Balance Sheet is Important

The value of a balance sheet is recorded as net assets balanced against equity. A healthy balance sheet forecast is the major component of any successful business plan.

Total assets less total liabilities, including contingent liabilities and provisions represent net assets and issued share capital plus retained earnings after tax and other capital items such as a share premium account represent equity.

A balance sheet in deficit spells technical insolvency.

Balance Sheet Assets

There are two classes of asset; current and non-current. 

Current assets represent cash, cash convertibles arising solely from core trading i.e. accounts receivable to be collected within one year and prepayments such as annual insurance policies.

Non-current assets represent fixed assets at net book value (i.e. cost less depreciation), investments unconnected with core trading such as shares in third party companies and intangibles (e.g. depreciated cost of temporary right of use patents or licencing rights).

Balance Sheet Liabilities

This starts with all debt, either current, i.e. payable within one year or long term, i.e. payable after more than one year.

Provisions such as for bad debts and contingent liabilities are included. The difference between the assets and liabilities represents a balance sheet's net assets.

Balance Sheet Equity

Attributable to shareholders, equity is principally made up of paid up share capital, retained profits (after tax) and perhaps a share premium account.

That describes how a company's net assets are funded by shareholders' interests. Hence equity balances against net assets.

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