How to Prepare Balance Sheet?
1. Introduction to Balance Sheet
Balance Sheet is one of topmost financial statement prepared by the businesses. The financial details of the balance sheet help you and the external stakeholders to evaluate the financial performance of the business on a given date. Before knowing the steps to prepare a balance sheet and reading the balance sheet, it is important to be familiar with the components and format of the balance sheet.
Knowing the balance sheet format, equations, components will help you to prepare a balance sheet easily. More importantly, knowing the fundaments will make you read the balance sheet without any complications.
Once you have through understandings of balance sheet basics, you can start preparing the balance sheet.
2. How to Prepare Balance Sheet?
Just like every other report, the source for you to prepare a balance sheet is from the transactions accounted in your books of accounts. In the process of preparing the balance sheet, you need to prepare other financial statements which will help you gather the accounting data. Let’s start with a step-by-step process to prepare the balance sheet.
3. Steps to prepare Balance Sheet
As mention in the above illustration, you need to follow 4 steps to complete the balance sheet. The steps are listed and explained below:
- Preparing Ledger Account
- Creating Trail Balance
- Making Trading and Profit & Loss account
- Finally, preparing the Balance Sheet
1. Step- 1 of the Balance sheet is to Prepare Ledger Accounts
From the transaction you have accounted in the Journal book (a book where day to day transactions are recorded), you must prepare an account statement for each ledger to determine the closing balance. This is because, a ledger account may have several transactions and there is no way that journal book will tell you the current balance of each account.
Here, preparing ledger account is nothing but posting all the Debit and Credit transaction into a statement belonging to a ledger account. For example, in preparing cash ledger account, you must post all Debit (Receipts) and Credit (Payments) into statement and difference between these two including the opening balance of cash will be the closing balance.
2. Step-2 is to Create Trial Balance
Trial balance is a summary of all the ledger accounts. It lists all ledger accounts with closing balance posted from individual ledger accounts statement (discussed above). The format of trial balance consists of the Debit column and Credit column in which the closing balance of each ledger accounts will be posted.
As a thumb rule, the total of debit balance in trial balance should match the total of credit balance. Only when it matches, it is assumed that the posting and ledger accounts are arithmetically correct. The purpose of preparing trial balance is to ascertain whether recording and posting of ledger accounts are correct. It’s the first statement in the process of preparing a balance sheet and hence, it always preferred to do a trial check whether every Debit is equal to Credit.
3. Step- 3 is to Make Trading and Profit & Loss Account
Profit and loss accounts is a financial statement prepared to know the profitability of the business. This consists of 2 sections namely Trading account and profit & loss account. Most businesses combine these two in a single statement and few, especially into manufacturing segment prefer to prepare separately.
Trading Account reflects the result of buying and selling of goods including the direct cost associated with it. It shows the gross loss or gross profit without considering the operational expenses and incomes. On the other side, profit & loss account shows you the net profit considering the gross profit/loss and all the indirect expenses and income.
Trading and Profit & loss account consists of all the ledger accounts having a nature of purchase, sales, direct expense and income, indirect expenses and income. While preparing Trading and profit & loss account, you need to post only the ledgers belong to above nature.
4. Step-4 is to Prepare a Balance Sheet
Now that you have prepared all the above statements, it’s time to prepare a balance sheet. You need to consider all the ledgers which are non-revenue in nature. In other words, all the ledgers expect the one which you have already considered for Trading and Profit & loss account should be considered for the balance sheet.
Broadly, the balance sheet consists of assets and liabilities. In the process of preparing a balance sheet, first, start with the assets side. Start capturing fixed assets ledgers like land and buildings, furniture, etc. and then investments and the all the current assets like cash, Bank, Accounts receivables, Closing stock etc.
Next step is to bring all the ledger having nature of liability under the liabilities side of the balance sheet. Remember, if there is any adjustment like depreciation, bad debts etc. you can do it in the balance sheet as well.
Once you have captured all details into the balance sheet, the assets side should be equal to the liabilities side of the balance sheet. Only then, your balance sheet is arithmetically correct.
4. Balance Sheet prepared by Modern day business
Traditionally, the balance sheet was prepared after the closure of the financial year. But with the modern-day business requirements, the balance sheet is looked upon as one of key financial statement for decision making. As a reason, it’s prepared quarterly/monthly or even monthly. Preparing balance sheet is not an easy task. It requires a lot of time and efforts in preparing the accounting data. To ease this, most businesses are using accounting software which automatically generates the balance sheet along with various other financial statements.