What is a ‘Balance Sheet’ ?
A balance sheet is a financial statement that gives information about a company’s assets, liabilities and shareholders’ equity at a particular point in time. These three segments of the balance sheet give investors an idea as to what the company owns(assets) and owes(liabilities), as well as the amount invested by shareholders.
The balance sheet holds fast to the following formula:
Assets = Liabilities + Shareholders’ Equity
Let’s Break Down ‘Balance Sheet’ :
The balance sheet is just an act to balance the two sides of the equation. The first side of the equation that is all the Assets should be equal to the sum of total Liabilities and shareholders’ equity in the company.
This is intuitive : A company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders’ equity).
For example, if a company takes out a five-year, 10 Crore Rupees loan from a bank, its assets – specifically the cash account – will increase by 10 Crore Rupees. On the other hand, its liabilities – specifically the long-term debt account – will also increase by 10 Crore Rupees, which balances the two sides of the equation. Now if the same company takes 20 Crore Rupees from investors, its assets will also increase by that amount, as will its shareholders’ equity. Now all the revenue the company generates in excess of its liabilities will go into the shareholders’ equity account, representing the net assets held by the owners. These revenues will get balanced on the assets side, appearing as cash, investments, inventory, or some other asset.
Question : What is an Asset ?
Answer : In a very simple language, An Asset is something that puts money in our pocket. An asset can be called as a resource with an economic value which can be converted into cash at any point of time or an asset can be thought of as something that in the future can generate cash flow, reduce expenses, improve sales, regardless of whether it’s a company’s manufacturing equipment, building or a patent on a particular technology.
Question : What is a liability?
Answer: In a very simple language, a liability is something that takes money from our pocket. Liability is the money that a company owes to outside parties, from bills that it has to pay to suppliers to interest on bonds it has issued to creditors to rent, utilities and salaries it has to give to its employees.
In a typical balance sheet, the equation looks like :
Assets = Liabilities
Below is the balance Sheet of Hero MotoCorp :
The first part in balance sheet is Equities and Liabilities.
Equities and liabilities are further divided into:
1 . Shareholder’s funds : Shareholders’ funds is the money attributable to a business’ owners, meaning its shareholders. It is also known as “net assets,” since it is equivalent to the total assets of a company minus its liabilities, that is, the debt it owes to non-shareholders.
Shareholder’s funds = Assets – Liabilities.
The main reason why shareholders’ funds is kept along with the liability side of equation and is not kept in asset side of equation because in real sense company is creating wealth for its investors that is the company owes some amount of money to the shareholders and thus shareholders’ funds are counted as a liability.
Below is the snapshot of shareholders’ funds of Hero MotoCorp:
Now to find out the share capital of a company we use the following formula :
Share Capital = No. of Shares issued by the company * Face Value of each share
Face value of Hero MotoCorp is Rs. 2 /- as visible in the below snapshot taken from NSE website.
Now since in below snapshot we can see that the Share Capital of Hero MotoCorp is 39.938 Crores and Face Value of hero MotoCorp is Rs. 2 /-.
No. of shares issued by the company = Share Capital / Face Value of each share
= 39,93,80,176 / 2
= 19,96,90,088 shares.
Below snapshot shows Number of shares in Hero MotoCorp which adheres to what we found in above equation :
The next line item on the liability side of the Balance Sheet is the ‘Reserves and Surplus’
a) Capital Reserve : A capital reserves is a type of account on a company’s balance sheet that is reserved for long-term capital investment projects or other large and anticipated expenses that can incur in the future.
b) Shares Premium reserves account : A share premium reserves account represents the difference between the par value of the shares issued and the subscription or issue price. For example, say a company issued 1,000 shares at Rs.10 par value per share. The company actually received Rs.15 per share as the subscription price. The difference between the par value and the subscription amount is the share premium. Thus, the additional Rs. 5,000 is placed in the share premium reserves account.
Hero MotoCorp has 0.87 Crore Rupees in shares premium reserves account.
c) General Reserve : General Reserve is used for strengthening the financial position and meeting future contingencies and losses. This money acts as a backup during the need.
Hero MotoCorp has 2645.79 Crore Rupees as General reserve.
4) Surplus in statement of profit and loss :
Let’s understand this with the help of the snapshot from Hero MotoCorp’s Balance Sheet.
a) As we can see in the snapshot, the surplus of Rs. 4104.93 Crore rupees of last fiscal year FY15 is added to the FY16 along with the profits, Rs. 3132.37 crore rupees made in year FY16.
b) Now the amount to be paid as dividend to shareholders (798.75 + 639) crore rupees and taxes (292.69) Crore Rupees is deducted from the total surplus amount we discussed in point ‘a’.
c) The other thing company does is transfer some amount of Rs. 250 Crores to General reserve so as to use in some unexpected future expense. This amount is also deducted from the surplus amount we discussed in point ‘a’.
d) After deduction, the closing balance comes to Rs. 5256.86 Crore Rupees.
Reserves and Surplus = capital reserves + share premium reserves account + general reserves + surplus in statement of profit and loss.
Click here for Part-2 where we will learn the Assets and Liabilities side of Balance Sheet in full detail in a very simple language.
Keep Learning and Keep Earning !!