FREE ESSAY ON THE BALANCE SHEET

THE BALANCE SHEET

The Balance Sheet
Although the balance sheet was first implemented just a couple of centuries ago, it has
quckly 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. 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 importance.
Bibliography
Bibliography:
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.