A balance sheet shows key information about the financial status of a company at a specific point in time. The balance sheet shows a company’s assets, liabilities, and shareholder’s equity. Unlike an income statement or statement of cash flows, the balance sheet does not show a range or period of time but rather the condition of the company at the exact time of writing.
The balance sheet reports the value of all assets the company currently has, the company’s liabilities, and the equity stake of all owners each divided into relevant categories. The balance sheet adheres to a basic formula:
Assets = Liabilities + Owners’ Equity
So the value of all the assets the company owns must equal the Owners’ equity, or stake in the company, with the value of the company’s debts added in.
The SEC requires all corporations to maintain a balance sheet and recommends any business to keep one. The balance sheet is crucial in determining the value of a company and is important to anybody with even the slightest interest in owning the company.
Balance Sheet Essential Knowledge
The balance sheet gets its name from the fact that the two sides of the equation above must balance. If the sides do not balance someone has made a mistake. This fact is intuitive: if a company needs to purchase something (add to the ‘Assets’ side of the balance sheet equation) it must take on debt (add to liabilities), take the money from investors (add to Owners’ equity), or use money from its cash reserve (a deduction from ‘Assets’).
Each component of the balance sheet equation is made up of many smaller accounts. These accounts vary widely across industries and carry different implications depending on the nature of the business. However, in general, the accounts have a few common components.
The ‘Assets’ segment of a balance sheet contains accounts listed from top to bottom in order of their liquidity or how easily they can be converted to cash. Two primary groups of the balance sheet are current assets, or assets that can be converted into cash with in one year or less, and non-current or long-term assets, assets that would take more than one year to be converted into cash.
In general, the following accounts appear on the balance sheet, in order:
- Current Assets
- Cash and cash equivalents: These assets are the most liquid. They include cash, treasury notes, and short-term certificates of deposit.
- Marketable securities: stocks and bonds that can be sold easily.
- Accounts receivable: all of the money currently owed to the company from its customers. Most of the time this account contains provisions for doubtful accounts, i.e. customers who are not likely to pay their bills so the money is lost.
- Inventory: the goods a company currently has for sale. When determining the value of the inventory a company uses the lower of the cost or market value.
- Prepaid expenses: expenses incurred by the company that have been paid in advance. For example, a company might rent many warehouses and pay a full years rent at the beginning of the year.
- Long-term Assets
- Long-term investments: investments that would require more than one year to be converted to cash.
- Fixed Assets: generally this account includes capital-intensive assets such as land, machinery, real estate, etc.
- Intangible assets: non-physical assets that still have value. This account can include things like goodwill or intellectual property.
A liability is money a company owes to outside entities. These accounts include bills owed to supplies, rent owed to landlords, utilities, salaries, etc. Like assets a liability is considered current if it must be paid within one year and long-term if the due date is any time after one year.
Some common accounts include,
- Current Liabilities
- Current portion of long-term debt: long-term debt is paid year after year, the current portion is the amount a company is required this year
- Bank indebtedness: money owed on lines of credits or other such accounts established with various banking entities
- Interest payable: interest paid on different forms of debt
- Rent, tax, utilities: any rent, tax, or utility bills
- Salaries (Wages Payable): wages paid to employees of the company
- Customer prepayments: if a customer pays for goods or services in advance the company will owe that customer until all services are performed or goods are delivered.
- Dividends payable and other: dividends paid to owners and other miscellaneous accounts
- Long-term liabilities:
- Long-term debt: principal and interest owed on issued bonds
- Pension fund liability: money a company pays to employee retirement accounts
- Deferred tax liability: accrued taxes that need not be repaid for another year
Owners’ equity is money attributable to a company’s owners, or shareholders. Because the owners’ equity is determined by a deducting a company’s liabilities from its assets, which can be found by arranging the equation above, it is sometimes referred to as ‘net assets’.