Balance Sheet shows the financial position of a business firm at a particular point of time. It is also known as the statement of financial position or statement of financial condition.


The major elements of the Balance Sheet are Assets and Liabilities. These two counter balancing elements form the Balance Sheet Equation.


Balance Sheet Equation:

                      Assets = Liabilities


Now, let us take an example to illustrate the preparation of a Balance Sheet.

Example 1.1

Let us assume that Royal Industries, a private limited company, has been formed by a group of 10 friends on 1^st June in the current year. Each friend has contributed Rs 3 lakh in cash. As a result of this transaction, the company's Balance Sheet would appear as follows:

It is understood that cash should appear under Assets but we need to know why capital is shown under Liabilities. For accounting purpose, a company/business firm is considered as an entity separate from its owners/promoters. This is known as the Principle of Separate Entity. This principle requires that every business transaction be viewed from the perspective of the firm and not from the point of view of the owners. It is for this reason, that the capital represents liability for the company as conceptually, company has the obligation to pay back to the owners. In the absence of this principle, it will be difficult to determine the true income (or loss) of a business firm because there will be no record either of the capital bought in by the owner(s) or the withdrawals (in cash off and on) made by them.


Let us further assume that out of Rs 30 lakh, Rs 20 lakh is deposited in a bank on 2^nd June by Royal Industries. As a result of this transaction, it is imperative that cash balance will reduce to Rs 10 lakh and a new item 'Bank Balance' will appear on the assets side.

Assume further the company purchases goods worth Rs 6 lakh against cash payment on 4^th June (Being a new firm, the supplier will not sell on credit and he may not accept cheque either). Evidently, cash reduces to Rs 4 lakh (Rs 10 lakh - Rs 6 lakh) and a new asset in the form of 'Stock of Finished Goods' would appear in Balance Sheet.

Do you see a similarity here? What happens in our personal life to our cash balance also holds true for the business records. Cash balance gets reduced when it is spent. Please note that no change has taken place either in the bank balance (as the firm has neither deposited into bank nor withdrawn) or in capital account. Two sides of the Balance Sheet again tally and the composition of assets only change. This equality will always exist unless the accountant has committed a mistake. In operational terms, it implies that every business transaction has two-fold effect. This is called the Principle of Duality/Double Entry. Additional transactions shown in this example will further re-enforce this contention.


During 5^th and 8^th June, Royal Industries has cash sales of Rs 5,00,000 (for goods costing Rs 4,00,000). Evidently, there is decrease of stock by Rs 4,00,000 (cost price) and increase in cash by Rs 5,00,000 (selling price). The difference between sales revenue and cost (that is of Rs 1,00,000) is Profit. As per the Separate Entity concept, profits are payable to the owners and, hence they are liabilities of the company.

Let us further suppose that the company decides to venture into its own manufacturing activity. For this purpose, the company buys a small industrial shed for Rs 8 lakh and machinery for Rs 10 lakh. The payment is made through a cheque on 15^th June. As a result, the Balance Sheet would be (please try on your own to draw it) as follows:

It is important to note that the composition of the Balance Sheet undergoes change with every business transaction (not necessarily in terms of gross total). Thus, in a way, Balance Sheet is a snapshot of financial position (in terms of assets owned and liabilities owed) of a firm at a particular point of time, say as on June 15. It is valid for that reference date/day only and its position is bound to change on the following day as soon as a new business transaction takes place.


Assume that Royal Industries is a relatively known entity and suppliers of goods and raw material are willing to transact business on credit basis. It purchases raw material worth Rs 3 lakh from Reliable Suppliers on credit on 18^th June. This transaction will be recorded in the name of 'Stock' (Raw Materials) on the assets side. As the sum is payable after the expiry of the credit period (say 30 days) to Reliable Suppliers, it will be shown on liabilities side and the two sides will be equal as per the Principle of Duality. (Please try to prepare a Balance Sheet on your own).