Overview and Definition

The balance sheet is a statement required of all public companies for their quarterly and annual statements. It's provided along with the cash flow statement and the income statement to allow investors and other stakeholders a means for analyzing the company's overall health. The balance sheet provides a look at the company's net worth and financial position in terms of its assets.

One can think of the balance sheet in terms of this equation:

Assets = Liabilities + Equity

The balance sheet provides shareholders a view of the company in a single moment, at the end of a fiscal period. Frequently, figures from previous periods are displayed along with the current numbers. This way, investors can measure the company's relative growth.

What Does the Balance Sheet Cover?

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Assets

The company's assets are comprised of the total cash on hand, equipment, property, inventories, and securities. The sheet is organized to reflect the ease with which each line item can be converted to cash. They are of two general types of assets: current assets which can be liquidated in under a year and non-current/long-term assets which will take longer to liquidate into cash.

  • Cash: This is the actual money a company has available for spending. It includes cash equivalents such as government bonds and positions in money market funds.
  • Money Owed to the Company (AR): Accounts receivable reflects cash owed the company by customers. Since not every customer will pay what they owe, accountants frequently note that AR might not be fully realized.
  • Inventory/Supplies/Land/Equipment: These assets are physical objects that can be sold for cash. Inventory is valued according to its cost to the company or its market value, whichever is lower.
  • Prepaid Expenses: These are expenses which are covered in advance. For instance, a company might pre-pay a rental expense for an entire year. Then, subsequent income statements will reflect an appropriate portion of the total prepaid amount for each month.
  • Investments: Investments can include items such as market securities (stocks and bonds), real estate, or private placements in companies. Investments can be considered current assets in the case of money market funds or securities that are intended for liquidation, or long-term assets which are not intended for short-term sale.
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Liabilities

Liabilities include all funds that are owed to third parties. Taxation is a type of liability, as is a line of credit. Like investments, liabilities are considered either long-term or short-term. A short-term liability should be paid off within a year and long-term liabilities are due to be paid at any point after a year. A small bridge loan might be considered a short-term liability while a mortgage is a long-term liability.

  • Debt: This is money owed to creditors for a range of items. Companies might accrue debt in order to finance more inventory or to fund research.
  • Money Owed by the Company (AP): This is the total of funds owed to outside entities, often for goods or services rendered. Retail companies take on AP liabilities to stock their shelves.
  • Rent: Since many companies don't own the property where they do business, they must pay out rent. Often companies will pre-pay rent and then account for it on each subsequent month's income statement.
  • Tax: Taxation is a reality for all companies and this liability must be accounted for on the balance sheet.
  • Utilities: In order to keep the lights on, companies must pay for the resources they use. Some might be able to strike a deal with the utility company and pre-pay their utility bills.
  • Wages Owed: Companies must pay their employees each pay period. Then there are other compensation issues including commission checks, bonus packages, and even benefits packages.

Owner’s/Shareholder’s Equity

The shareholder’s equity in any company is also known as the net assets or net worth of that entity. Once the total assets are calculated and then all the liabilities deducted, the remaining assets comprise the total value held by the shareholders. Another way to think of net worth is that it is what remains after a company pays off all its liabilities.

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What’s It Used For?

The balance sheet is used to show the present-day worth of a company. The current period's balance sheet might demonstrate great value or dangerous debt, but a balance sheet's true value comes when investors compare a company's balance sheets over time. It might be interesting to review the balance sheets from multiple years, but the company's financial story is even further developed when one reviews the most current quarterly statements, as well. This can help investors make investments at the most opportune moments. For example, if a company's overall worth declines at the same point each year, due to seasonal shifts, that might be the best time to invest.

Taken by itself, the balance sheet demonstrates the company's current liquidity. The balance sheet is also used on conjunction with the income statement to determine a company's efficiency, and what the statement reveals helps investors determine how well the entity is leveraged. The sheet also enables analysts to calculate return on equity, return on assets, and return on invested capital.

Its Limitations

The balance sheet is inherently limited by the fact that it only offers a snapshot in time and says very little about the company itself. The balance sheet only shows a company's total worth at a specific period in time. It does not address pertinent financial details such as the company's income or its cash flow. Other statements must be used alongside the balance sheet to provide more depth in terms of how the company manages its assets and liabilities, which the balance sheet only quantifies as static elements.

However, it is possible to compare year-by-year balance sheets as a way to seek trends or patterns. More depth might be reached when one includes quarterly statements and examines other filings, as well. However, it cannot be used in exclusion of the other financial statements if one is seeking a comprehensive picture of a corporation.

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