Balance Sheet
A balance sheet is the date-specific comparison of a company’s assets and its capital (equity and liabilities) at a fixed point in time. It shows which resources exist and how they were financed – both sides are always equal in amount.
A balance sheet is the monetary comparison, drawn up as of a fixed reporting date, of a company’s assets and its financing (equity and liabilities). The left side shows which assets the resources are invested in – from machinery to inventory to bank balances. The right side shows where these resources come from: from the shareholders’ equity or from debt provided by banks and suppliers. Because every euro of assets must somehow be financed, assets and liabilities are always equal in value – the balance sheet „adds up“.
Alongside the profit and loss statement, the balance sheet is the core of the annual financial statements under commercial law. It is a snapshot: it describes the state of the company exactly on the balance sheet date, usually 31 December. It is prepared from the balances of all balance sheet accounts in the accounting records; its form and minimum content are prescribed by law for merchants in the German Commercial Code (HGB). In practice, the financial accounting of an ERP or accounting system today usually generates the balance sheet automatically from the postings recorded on an ongoing basis.
At a glance
- Date-specific comparison of assets and equity/liabilities (capital)
- Accounting equation: total assets = total equity and liabilities – both sides always equal
- Assets ordered by liquidity, liabilities by maturity (§ 266 HGB)
- Part of the annual financial statements – together with the profit and loss statement
- Automatically derived in the ERP system from the balances of the balance sheet accounts
How a balance sheet is structured
A balance sheet is presented in account form: assets on the left, equity and liabilities on the right. The asset side lists the company’s resources, ordered by increasing liquidity. First comes fixed assets – long-term values such as land, buildings, machinery and participations – followed by current assets, i.e. short-term available items such as inventory, trade receivables and bank and cash balances. The further down an item appears, the faster it can be converted into cash.
The equity and liabilities side shows the origin of the resources, ordered by decreasing maturity. At the top is equity (subscribed capital, reserves, retained earnings), followed by provisions and finally liabilities to banks and suppliers. The decisive point is the accounting equation: the sum of assets always corresponds exactly to the sum of equity and liabilities. This identity is not a coincidence but a necessary consequence of double-entry bookkeeping, in which every business transaction is recorded at equal value on two sides.
Classification under § 266 HGB
For corporations, § 266 HGB prescribes a binding classification scheme. Assets are divided into fixed and current assets with firmly specified sub-items (such as intangible assets, tangible assets, financial assets, inventory, receivables, securities, liquid funds). Equity and liabilities are divided into equity, provisions, liabilities and deferred items. The level of detail depends on the size class: small companies may draw up an abbreviated balance sheet, large ones must show the full depth of classification.
Why the balance sheet matters
The balance sheet is the central source of information about a company’s asset and financial position. From it, key figures can be derived that are equally decisive for banks, investors, suppliers and management: the equity ratio as a measure of financial stability, the debt ratio, the liquidity ratios or the fixed asset coverage ratio. A lender uses the balance sheet to check whether a company is creditworthy; an investor assesses its substance from it.
Legally, preparing a balance sheet is mandatory for merchants. Anyone required to keep accounts under HGB must prepare a balance sheet at the end of each financial year and – depending on legal form and size – disclose it or submit it to the tax office. Together with the profit and loss statement, the balance sheet forms the basis for determining the taxable profit. Incorrect or incomplete balance sheets lead to objections during tax audits and can have liability consequences for management.
The balance sheet in the ERP system
In an ERP system, the balance sheet is not created through manual compilation but is generated automatically from the balances of all balance sheet accounts. Every business transaction – goods receipt, outgoing invoice, incoming payment, depreciation – generates journal entries that run through the general ledger accounts of the chart of accounts. Via the assignment of these accounts to balance sheet items, the system can output a preliminary balance sheet at the push of a button at any time. This way, management and accounting see how assets and capital are developing on an ongoing basis, not just at year-end.
The prerequisite for a correct balance sheet is clean account logic: balance sheet accounts must be correctly assigned to the asset and liability items, fixed assets and depreciation must be maintained consistently, and open items from accounts receivable and accounts payable must be fully transferred. Many mid-sized companies use the ERP’s integrated financial accounting for ongoing recording and hand over the data for the formal annual financial statements to the tax advisor via the DATEV interface. How deeply a system maps the accounting itself differs by product – examples can be found under „Related systems“.
Commercial balance sheet and tax balance sheet
In the DACH region, a distinction must be made between the commercial and the tax balance sheet. The commercial balance sheet follows the HGB and serves to inform shareholders and creditors; the prudence principle shapes its valuation. The tax balance sheet is derived from the commercial balance sheet via the authoritative principle (Maßgeblichkeitsprinzip), but corrects items where tax law requires different valuations – for example in depreciation or provisions. An ERP system must support both views or at least provide the basis for the tax reconciliation.
Distinction: balance sheet vs. P&L, inventory list and annual financial statements
The balance sheet is often confused with neighbouring terms. The profit and loss statement (P&L) does not look at the stock at a reporting date but at the expenses and income of an entire period and determines the result from them. The balance sheet and P&L are linked via equity: the profit determined in the P&L increases equity in the balance sheet. While the balance sheet is a snapshot, the P&L is a period-based view.
The balance sheet must also be separated from the inventory list: the inventory list is the detailed record of all assets and liabilities by quantity and value, which results from the physical stocktaking. The balance sheet, by contrast, is the condensed short form of it, summarised into accounts. Finally, the annual financial statements are the umbrella term: they comprise at least the balance sheet and P&L, and for corporations additionally notes and in some cases a management report. The balance sheet is therefore a component of the annual financial statements, not identical with them.
Example
Example: balance sheet of a mid-sized online retailer
An online retailer prepares its balance sheet as of 31 December. On the asset side, fixed assets include the operating and office equipment of the warehouse (40,000 euros), while current assets include inventory (120,000 euros), open receivables from customer invoices not yet paid (30,000 euros) and the bank balance (60,000 euros) – 250,000 euros in total. The accounting department draws these figures directly from the balances of the balance sheet accounts in the ERP system; the inventory is based on the stocktaking carried out as of the reporting date.
On the liabilities side there is equity of 100,000 euros, a bank loan of 90,000 euros and trade payables to suppliers of 60,000 euros – likewise 250,000 euros. Both sides are equal in amount, the balance sheet adds up. The ratio of equity to the balance sheet total yields an equity ratio of 40 percent – a figure the house bank will examine at the next credit negotiation.
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