What is balance?
According to the online etymology (origin of words) dictionary the word “balance” comes from Latin and is a composite of the words “bis” or “two” and “libra” or “scale”, combined as “bilanx” or “double pan scale”.
You might have seen one in a grocery shop if you were born in the last century. Even if you are a millennial you would know what a two pan scale looks like from having seen images of the Goddess of Justice and the scales she holds in her hands.
A two pan scale is used to work out equality between what is put in the two pans of the scale.
That idea has been picked up in how businesses account for their transactions, except that they don’t measure transactions on an actual scale but on a sheet of paper. The left and right side of what’s recorded on that sheet are always in balance.
So what is a Balance Sheet?
On one side of the Balance Sheet are listed the resources of a business – things such as land, property, inventory, cash. They are known as assets.
On the other side of the Balance Sheet are listed the sources of funding with which those resources were acquired by a business – that is through funding provided by the shareholders and borrowing from third parties (creditors).
The Resources are always equal to the Sources of Funding. Hence the Balance Sheet, which in effect shows the financial position of a business at a point in time () is always in balance.
What is captured on the Balance Sheet can also be explained by using an equation which is known as the Accounting Equation:
Assets = Liabilities + Shareholders’ Equity
(with the Resources or Assets on the left side of the equation and the Sources of funding namely Shareholders’ Equity and Liabilities on the right side of the equation; an equation being about equality of both sides).
So if a brand new business has £10m worth of land, £2m worth of equipment and £5m of cash and if the shareholders invested £11m in the business to set it up, by using the accounting equation it is possible to work out how much was borrowed by the business:
Land £10m + Equipment £2m + Cash £5m = Liabilities? + Shareholder’s Equity £11m
Assets £17m = Liabilities? + Shareholder’s Equity £11m
Liabilities = Assets £17m – Shareholders’ Equity £11m = £6m
The way the business will present all that in its Balance Sheet will look something like this:
Balance Sheet for A Brand New Business Ltd as at this point in time
Another way of presenting the accounting equation is:
Assets – Liabilities = Shareholders’ Equity
It is still an equation and still in balance. The same thing, just mathematically reworked.
So the Balance Sheet may also look like:
|(Net of) Liabilities||(£6m)|
Essentially the two examples of Balance Sheets contain the same information, just organised slightly differently.
A real-life example – J Sainsbury
You can look up the annual reports and financial statements of companies on the internet. Most big (especially listed on the stock exchange) businesses make theirs available to shareholders and potential investors on their investors’ relations section of their websites. Even the financial accounts of small businesses could be accessed for a small fee from Companies House in the UK.
The Balance Sheet is one of the primary financial statements included in these published accounts.
Let’s peek inside one of them. For example the 2021 Annual Reports and Financial Statements of J Sainsbury’s, a supermarket.
An abbreviated version of Sainsbury’s Balance Sheet looks like this:
J Sainsbury’s Consolidated Balance Sheet as of 6 June 2021
|(Assets – Liabilities)|
As you can see there is quite a lot more detail than the earlier example we looked at. For example assets and liabilities are grouped into current and non-current. Current assets are those that are intended to be liquidated and turned into cash in the next 12 months after the balance sheet date whereas non-current assets are intended to remain in the business for a longer period. Similarly, current liabilities are liabilities that have to be paid in the next 12 months after the balance sheet date whereas non-current liabilities have to be settled beyond that point.
Even more, detail is provided on the Balance Sheet about the types of assets (both current and non-current) as well as liabilities (current and non-current) and even equity.
But the main point of looking at this example is to illustrate that the Balance Sheet is in balance. The sum total of all of J Sainsbury’s resources (its assets) of £25,162m is equal to the sources of funding: liabilities of £18,558 and shareholders’ equity of £6,604m.
Assets £25,162m = Liabilities £18,558 + Shareholders’ Equity of £6,604m
Assets £25,162m – Liabilities £18,558 = Shareholders’ Equity of £6,604m
Another thing that we see in J Sainsbury’s accounts is that the Balance Sheet shows comparatives for last year – what assets, liabilities and shareholders’ equity were last year. And surprise, surprise – that prior year balance sheet is also in balance! The top part is equal to the bottom part of the Balance Sheet for both the current and the prior year. The invisible two pan scales are perfectly balanced.
What if the balance sheet doesn’t balance?
The way transactions are captured during the course of business involves symmetry, balance. The accounting equation always holds true. The Balance Sheet where Assets, Liabilities and Shareholders’ Funds are disclosed then will also always be in balance (the Resources or Assets in the top part of the Balance Sheet will always be equal to the Sources of Funding namely the sum of Liabilities and Shareholders’ Equity in the bottom part of the Balance Sheet). IF they don’t – there must be an error which the accountant will investigate and correct so that there is balance on the Balance Sheet.
What if there is no balance and no sheet?
Symmetry is one of the wonderful properties of accounting records. If there is no symmetry or balance the accountant will know something is not quite right with the records and will have to rectify the error until the balance is restored to the Balance Sheet (still called that even when accounting records are no longer kept on sheets of paper but on computer screens).