Balance Sheet Essay

Although the balance sheet was first implemented just a couple of centuries ago,
it has quickly developed and sophisticated to become nowadays a widely used and
powerful tool in the hands of professional users, well known and popular even
among the mass public. In spite of its prominence, or may be because of it, the
balance sheet can not be easily and fully described in a few words, but still,
if we leave aside its various functions and forms and any other subjective
factors, we can state that the balance sheet is a summary of an enterprises’
assets, liabilities and equity at a specific moment of time. To simplify this
description even further we could say that the balance sheet shows an entity’s
possessions, obligations and others’ debts to it. The “objective”
point of view however is often too restrictive, and the most simple things many
times prove to be rather complex… Among the thousand more complex definitions
appended to the balance sheet one of my favorites is the definition given by
…. according to which the balance sheet is a statement meant to communicate
information about the financial position of an enterprise at a particular point
in time, summarizing the information contained in accounting records in a clear
and intelligible form, giving information about the financial state of an
enterprise and indicating the relative liquidity of the assets, showing the
liabilities of the enterprise (i.e. what the enterprise owes and when these
amounts will fall due), able to assist the user in evaluating the financial
position of the enterprise, being however only part of the data needed by users.

Or to summarize this long description with which I completely agree, I could say
that although the balance sheet is one of the most outstanding instruments in
the hands of financial analysts, managers, investors and other users, its
importance should not be over emphasized, it has to be viewed along with many
other documents, and it is far from being the perfect and the “super”
financial document. In order to get a more clear, complete and fair picture of
the balance sheet, apart from reviewing the definitions given by the experts in
this field, we would need to consider as many sides and issues of the subject as
possible. Being objective we should have a look at the etymology of the word
“balance”, the history of this document, its theoretical essence and
the basic concepts of accounting implied in it, its forms in the accounting
practise. In our attempt however not to become “over-objective” or
scholastic, we should also review the aims and purposes of the balance sheet and
the extent to which they are fulfilled, the users of this financial statement
and their contradictory needs, the negative aspects and restrictions of the
balance sheet, and finally the trends of its further development. In short, we
have to go further into the matter… The history of the so called financial
statements, and the balance sheet among them, can be traced back to Renaissance
Italy, where along with the double – entry book – keeping they first evoked to
respond to the growing more and more complex needs of the accounting connected
with the economic development of the society at that period (expansion of trade
activities, development of banking, etc.) and with the transition from the owner
– manager model towards limited companies or the breakdown of ownership from
control. Obviously these historical events called for the development of new
methods and new documents, reflecting the changes. Naturally the word
“balance” itself has also an Italian origin (“bilan”, “bilanz”)
though it is formed up of two latin words: “bi” – double and “lanx”
– scales. Even from here it becomes obvious that the balance sheet is a sheet or
summary of two different aspects of one and the same thing: an entity’s
financial position. Further to this aspect, we can take a look at the definition
of the balance sheet given by John Arnold, Tony Hope and Alan Southworth:
“The balance sheet is the most inituitive and easily understood document of
accounting. Most of us at some stage in our lives will be required to compute a
listing of our possessions. Such a listing of possessions is a major element in
the construction of a balance sheet.”. Far from being a precise statement
on what the balance sheet is, it can easily be perceived from a phylosofical and
psychological view point, and then, though defined at present times, it can be
related with the historical side of the balance sheet. The link is as simple as
that: one would generally describe his possessions by listing the things he has
and those that should be returned to him, as well as his debts to other people,
further more, he would intuitively put those “lists” on the scales to
find out what his financial state is, or “to get the balance”. To
extend this etimological analogy a bit more, by putting on the different sides
of the scales the lists of his possessions and his debts, one would, probably
intuitively, measure his financial position with the height difference that
would occur between the sides of the scales. Then, in the prossess of separation
of the owner from the manager, this way of measurement of a person’s financial
state, was naturally transferred into what we now call an enterprise’s balance
sheet. Furthermore, the fundamental method of “scaling” possessions
and debts continues be the basis of this document. As we all know a fundamental
characteristic of every balance sheet is that the total figure for assets always
equals the total of liabilities plus owners’ equity. As we have already seen,
actually the above simple equation, representing the theoritical essense of this
document, and a basis of its practical side, is the reason for it to be called
balance. Actually, the two sides of the balance sheet are merely two views of
the same business property. Having defined the essence of the balance sheet, in
theoretical aspect we have to review the concepts in accordance with which it is
built up. Since it is an accounting document, obviously, we would have to find
out the application of the basic accounting principles in it. Further to this we
can deffinitely state that the balance sheets is in complince with all of the
basic accounting principles and concepts. Let us review some of the most obvious
principles that can be referred to the balance sheet: The entity principle: as
in all accounting documents in the balance sheet an enterprise is presumed to
exist in its own right. It is therefore treated as a separate entity from the
person or persons who own or operate it and in no way reflects their assets or
liabilities. The same applies equally to organizations that are not commonly
referred to as businesses (charities, clubs, etc.). The money-measurement
concept: obviously everything shown on the balance sheet is measured in money,
all pointers that cannot be expressed in monetary terms, being left aside; The
cost principle: I would classify this one as may be the most contradictory
principles not only in the financial statements but in the accouning itself. I
can even add that it is the reason for some of the negative aspects of the
balance sheet. In spite of the different ways in which assets can be valued the
accountants have traditionally used the historic cost as the basis of valuation
of assets in the balance sheet, assuming that the enterprise is a
“going-concern”, and taking into consideration the need for
objectivity. Periodicity principle: being a document, showing the financial
position of a firm on a given date, by its very nature the balance sheet has to
be drawn at a some periods of time, so there is no way for it not to comply with
this principle. As already mentioned the balance sheet can be easily referred to
and found in complience with any other concepts like the accrual concept, the
duality concept, the prudence principle, etc. To finish with the aspects here
referred to as “objective”, we have summarize in short the practical
side of the balance sheet. No matter how often it is drawn, and what of the two
popular forms it is presented in, the balance sheet, as known, consists of three
major parts: assets – or what the firm possesses and has the right receive in
future; liabilities – or what the firm’s obligations are; shows also how many of
these should be returned in the short-run, and how many the enterprise can
employ in the long-run; owner’s equity – the firm’s capital, it can be also
figured as the differense between assets and liabilities. To summarize the
theoretical and practical essense of the balance sheet, we can use another
contemporary definition of it given by A. Belkaouli in “Accounting
theory”: “The balance sheet measures the financial positions at a
point in time”. I think the arguments of the author are clear: if we assume
that the current financial position can be described with the figures of the
firms’ possessions and obligations, listed by types and amounts than we would
have to agree that the balance sheet gives us this information. Obviously, being
an indicator of the enterprises’ financial position, the balance sheet is a
useful and powerful tool in the hands of managers, financial analysts and
external users. Combined with the data on other financial statements it forms
different ratios (like short-term liquidity ratios, short- and long- term
solvency ratios, asset utilisation ratios and many others), which are the basis
of each financial analysis. It is these data that can tell you if a company has
enough money to continue to fund its own growth or whether it is going to have
to take on debt, issue debt, or issue more stock in order to keep on keeping on.

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Does a company have too much inventory? Is a company collecting money from its
customers in a reasonable amount of time? Once again, it is the balance sheet –
the listing of all of the assets and liabilities of a company – that can tell
you all of this. And once again, its understanding is crucial for the management
of the company, potential investors, and many other users. Now, having in mind
all afore said, let us view another definition of the balance sheet: “You
can not have a more meaningless and confused statement holding a position of
such a great importance” (Keron Bhattacharaya, “The accountancy’s
faulty sums”). Interesting opinion… In order to find out this authors
points of view we will have to consider the balance sheet restrictions and
limitations and the needs of its users, or at least some of them. The balance
sheet is in essence a list of the assets and liabilities of the enterprise or
organization at a point of time. The fact that it represents the position at one
point in time is itself a limitation as it is only relevant in that point of
time. At any other time a new sheet has to be drawn up. This means that in order
for the balance sheet to be useful it should be as up to date as possible, and
that its utility diminishes the more out of date it becomes. Similarly, in order
that it is an accurate measure of the assets and liabilities should be as up to
date as possible, and here lies another limitation. Another very strong
limitation of the balance sheet is the fact that the costs are given in their
historical expression. Although, as prevoiusly stated, this has its reasons,
still in some cases it blurs the information on the sheet. This is especially
true applied to the accounting in high – inflation environment, and is probably
one of the reasons for the opinion of the South Asian author – Keron Bhattaraya.

But even in normal economics sometimes the assets being stated as a figure which
bears little if any relation to the current value (the most obvious example of
this in recent years has been the changes in prices and values of land and
buildings). This is a serious contradiction and recently there has been a trend
showing assets in public accounts at a valuation rather than at a historical
cost. Another short-coming of the balance sheet is its monetary expression.

Little information can be drawn out of it on the enterprises’ activities, the
profit of certain investments or managers’ decision, the success of new
products, the company employees. It would be impossible however to show all of
these in one-sheet summary. As I have early pointed the balance sheet itself is
a contradictory document also because of the various needs of its numberous
users and environments in which it is used. The activity in which the
organization is involved can have dramatic effects on the classification of an
asset. What might not be an asset for one business would be an asset of another
business, undertaking a different activity. Apart from these cases, which are to
some extent reasonably clear cut, the activity can have dramatic effects on the
difficulty or otherwise of drawing up a balance sheet. Consider for example the
problems of a football club, trying to account for star players; or of a high
technology business, trying to decide whether the cost of the patent on a new
product is going to yield any future benefit when the state of the art is
changing so rapidly. There are also issues related to the ways in which a
business is perceived and the ways in which the management would wish the
business to be perceived. For example a research has shown that the management,
especially the management of smaller organizations, perceive that the bankers
are interested in the amount of assets available as security for a loan or
overdraft. There is therefore a temptation to try to enhance the value of assets
perhaps by revaluing the land and building prior to applying for a loan.

Similarly in a number of cases where a business is in trouble the assets have
been revalued in order to bolster the image of the business and to promote the
impression of it having a “sound asset base”. In one word, what seems
good and right to me, may not be enough for you. Still, there are many users to
which the balance sheet does not seem confused and is necessary, although they
have conflicting needs: IRS and other government and state institutions. It is
probably fair to say that income statements are constructed with the IRS in mind
more than any other user. After all, it is the bottom line of the statements
that determines what taxes will be due. Lenders are more interested in balance
sheets, although the income statement is not taken lightly. The first question a
lender must ask is “What if this loan is not repaid?” The lender will
want something to sell to get paid back. A company’s balance sheet tells the
lender what there is to sell. So a lender wants a balance sheet that indicates
what the company owes (its liabilities) and what it owns (its assets). Assets
include such obvious things as property and cash, but also accounts receivables
(what the company is owed) and prepaid expenses (like advances on rent). Things
the company owes (“accounts payable”) include debt and bills yet to be
paid, as well as what stockholders put into the business (“stockholder
equity”) and retained earnings (profit not paid out to stockholders in the
form of dividends or other payments). Lenders also want to look at the income
statement, but they may be more interested in a cash statement. The IRS wants to
know how much profit you make, but wants profits to be adjusted to account for
depreciation (wear and tear) on assets the company owns. The lender finds that
interesting, but the lender will not be comforted by the fact that the $1
million you spend on a new building will be depreciated over 10 years when the
loan is for three. Finally, of course, shareholders want to look at income
statements and balance sheets. They give snapshots of the current health of the
business. They may be less interested in any one period’s report than the trend.

Are profits getting better? Is the balance sheet fatter? That’s because the
share value does not have a simple relationship to either the balance sheet or
the income statement. The value of a business is based on what someone would pay
for it to gain control of the money it will make in the future. The balance
sheet gives this potential buyer an idea of how easily the company can finance
future growth and weather financial crises; the income statement gives the buyer
an idea how much future profits might be. But an investor would need to know a
lot of other things before coming to a decision about how much to pay. For
people running the company, the financial statements are just a starting point.

The really interesting numbers may not show up on a statement, such as the
profit margins on various products, projected sales, or order backlogs. The
financial statements pull all these things together, but any analysis of how a
company is doing needs a different kind of operational data. The best employee
ownership companies share these numbers too. Now, having reviewed almost all the
issues related with the balance sheet, we can say in my opinion that sine its
appearance a few centuries ago it has been an important and outstanding
financial statement summarizing the financial position of an enterprise at a
particular point in time. In the quickly developing technological environemt it
might change its form, it might even change some of its principles, it will be
viewed along with more and more information in the era of information, but it
will keep for some more time its “position of such a great

Arnold J., and S. Turley, Accounting for Management Decisions, 3rd ed., 1996,
Prentice Hall Europe (UK) Limited, London Berry A. and R. Jarvis, Accounting in
a Business Context, 2edshnvd. ed., 1994, Chapman & Hall, London Watts J.,
Accounting in the Business Environment, 2nd ed., 1996, Pitman Publishing, London
Adam, J.H., Longman Dictionary of Business English, 2nd ed., 1989, Longman Group
UK Ltd.


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