Balance Sheet – The Mystique!!

Category: Knowledge Series-1
Author: Giridhar Narayanan

2nd November, 2018, Friday: For most of the small and medium business owners, or should I say, technocrats, the word “Balance Sheet” only exists because there is compliance around it from the governmental agencies and it is the sole purview of their auditors to prepare the same. They just about imprint their autographs on it (sign it) and relegate it to the reams and stack of files for their accountant to maintain.

The truth can’t be any more different. But, the Balance sheet is a reflection of where the business currently stands – Combined with Profit and Loss Statement, the Balance Sheet is numeric representation of all the operational activities that you’ve undertaken in your business. Isn’t that what the owner’s and the managers in any business would want? – to know the company’s operational standing at any given point in time. Given that this is exactly what a Balance sheet does along with the P&L , it might seem ludicrous to not to refer to the same as point of reference for future decision making activities.

Let us demystify what the Balance Sheet does!
The Balance Sheet is simply a table which provides you with the sources of funds, known as Liability and application of funds, known as Assets. To illustrate this better, let us assume that you have invested Rs. 100 in your business at the start, the balance sheet (the firm’s balance sheet) will tell you that on the Sources of funds (Liability), it has Rs.100 earmarked under capital and application of funds side (Assets), it has Rs.100 sitting on it’s bank account.

Sources of Funds ( Liability) Application of Funds (Assets)
Capital
100
Cash in hand / Bank
100
Total
100
Total
100

So you can see that at any point in time, the sources of funds must be equal to your application of funds i.e. the two sides of the Balance Sheet namely Assets and Liability Always add up to the same amount.

The above table is a very basic / primary illustration of the how the Balance Sheet works, however the logic behind recording all the other more complex transactions is the same.

Let’s delve a bit into further detailing of the components of Balance Sheet and how it is structured. As we have understood from the earlier explanation, the Balance Sheet is split into Liabilities and Assets. It can be further classified into Short Term & Long Term Sources and Application of Funds. The Illustration of the same is given below:

Sources of Funds (Liabilities) Application of Funds (Assets)
Short Term Sources (Current Liabilities) Amount Short Term Application / Uses ( Current Assets) Amount
Working Capital Finance From Bank Cash/ Bank
Creditors Debtors
Provision for taxation Inventory
Other Statutory Liabilities Advance Payment of tax
Advance from Customers Advance to Suppliers
Others Others
Total Short Term Sources (A) XXX Total Short Term Uses (A) XXX
Sources of Funds (Liabilities) Application of Funds (Assets)
Long Term Sources (Non – Current Liabilities) Amount Long Term Application / Uses ( Non – Current Assets) Amount
Capital Fixed Assets
Reserves and Surplus Security and Deposits
Share Premium Other Investment
Term Loan Loans and Advances
Unsecured Loans from promoters & family Debtors > 12 months
Total Long Term Sources (B) XXX Total Long Term Uses (B) XXX
Total Sources of Funds (A+B) XXX Total Uses of Funds (A+B) XXX

The knowledge on the various components mentioned in the Balance Sheet and what they represent have to be gained before one can confidently start deciphering what the Balance Sheet states. This has to be done independently to start de-coding the picture that the Balance Sheet is painting.

The purpose of this article is only to start you on your journey of understanding what the Balance Sheet represents. Hope we have steered you in the right direction and you have successfully taken your first step towards unravelling the “Balance Sheet Mystery”.