Objectives of the Balance Sheet

Written by True Tamplin, BSc, CEPF®

Updated on March 29, 2022

The general objective of the balance sheet is to describe the firm’s economic condition at a point in time. In its broadest theoretical sense, economic condition is the firm’s ability to continue operating and, thus, is based on both earning power and solvency.

Due to the practical difficulties of assessing this theoretical ability, accountants apply a limited definition of a company’s economic condition known as financial position.

The concept of financial position restricts the balance sheet to disclosures about the firm’s assets, liabilities, owners ‘ equity, and other financial matters.

Accountants have developed this simplified approach because the broader concept is too abstract to be useful.

To explain this abstract concept further and to show why it is not used by accountants, it is helpful to show how a firm’s economic condition is similar to a person’s physical condition.

Both physical and economic conditions are influenced by a large number of factors. Some factors can be described and measured using objective methods, but many cannot be precisely measured and, therefore, are evaluated only subjectively.

For example, in a human being, physical factors such as heartbeat, respiration rates, and blood chemistry can be measured precisely, but an individual’s mental state can generally be assessed only subjectively.

Similarly, a firm’s cash, receivables, and notes payable can be measured fairly precisely. However, critical factors such as managerial competence and the strength of product demand cannot be measured with sufficient reliability.

Consequently, accounting practice does not attempt to deal with these kinds of variables despite their obvious impact on a company’s economic condition.

Apart from the problems of assessing physical and economic conditions, it is helpful to identify the roles of the parties that perform the assessments.

For human beings, it is typical for nurses, physician’s aides, or other paraprofessional staff to carry out routine examinations and other procedures to gather data to be studied by the physician when developing an opinion, diagnosis, and treatment plan.

Similarly, private accountants and auditors work together to gather data about a firm and present it to the users of the reports. It is the users that perform the evaluation and plan future actions.

It would be inconsistent with their role (and expertise) if accountants were to engage in the extensive analysis required to report economic condition in the broader sense described in the first paragraph of this article.

For all these reasons, the balance sheet describes a company’s financial position in terms of its assets, liabilities, and owners’ equity, as well as in terms of other disclosures that have been identified as useful.

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About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.