What is a Balance Sheet?
The balance sheet is a financial statement that shows what an entity owns and owes plus the total amount invested by investors. Specifically, it lists an entity’s resources, obligations, and owners’ claim at a point in time.
It is used alongside other financial statement to assess the overall performance and health of a company through the use of financial ratios such as return on investment and return on assets.
The Balance Sheet includes:
- Assets (A)
- Liabilities (L)
- Equity (SE)
The Accounting Equation
Also called the balance sheet equation, it is the most significant expression in accounting. It represents the main relationship between the two principal sections of the balance sheet: (1) assets, and (2) liabilities and equity.
Assets = Liabilities + Equity
This equation is fairly straightforward as it puts into mathematical form a basic accounting and financial concepts. An entity has to pay what it owns (i.e., assets) by issuing debt(i.e., liabilities) or raising capital (i.e., equity).
For instance, say a company in the consumer goods sector needs to raise 4,000,000.00 SGD to invest in Research and Development to design and produce a new product. Then, it can either take on debt by asking for a loan or issue 4,000,000.00 in stocks. By increasing liabilities or equity by 4 million SGD, its cash reserves will also increase by that amount. Hence, the equation remains balanced.
Assets are all the resources owned by an entity (e.g., company) and represent probable future economic benefits.
They can be split up into tangible and intangible assets. Tangible assets represent “physical” and “concrete” resources, such as cash, inventory, and land. Intangible assets usually represent contractual right benefits (e.g., patents and trademarks).
Assets can be further divided into current and noncurrent assets, depending on their liquidity. Current assets are resources that are expected to be converted into cash within one year. All the remaining assets are noncurrent. This distinction is necessary to understand the overall liquidity of a company using acid-test ratios and current ratios.
The most important assets accounts are:
- Cash and Equivalents
- Accounts Receivables
- Property, Plant, & Equipment (PP&E)
- Prepaid Expenses
- Accumulated depreciation
Liabilities are the total amount that is owed to external entities (i.e., creditors) and represent probable future sacrifices. They can arise as a result of asset transfers, future prepaid services to other entities, and past transactions.
Similarly to assets, they are classified into current or noncurrent liabilities. Current liabilities are obligations that will be paid within one year. The remaining liabilities fall into the noncurrent classification.
In the case of liquidation or bankruptcy, an entity must pay back first its liabilities to its creditors.
The most important liabilities accounts are:
- Accounts Payable
- Unearned Revenue
- Rent, Utilities, and Wages Payable
- Notes Payable
- Interest Payable
- Long Term Debt
Equity is the money attributable to an entity’s stockholders, partners, or owners. In its purest form, it is an ownership right. It is often referred to as net assets since it is equivalent to assets minus liabilities. Another term sometimes used is net worth.
The most important equity accounts are:
- Paid-in Capital
- Common Stock
- Preferred Stock
- Additional Paid-in Capital
- Retained Earnings
- Non-controlling interest
In a Nutshell
Put It To Test!
Public companies usually publish their financial statements on a quarterly and annual basis. You can find US-based public company’s balance sheets on the US Securities and Exchange Commission (SEC) website. Search for the 10-K, and you will be ready to go!
Alternatively, you can also learn more about the balance sheets and understand how it helps in financial analysis by signing up for an online course* on Udemy. Click on the link to get exclusive discounts.*
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