Overview and Definition

The balance sheet is one of the financial statements required of all public companies for their quarterly and annual statements. Even a privately held small business should prepare year-end financial statements for review by executives, management, and private investors. Each SEC filing must include the following financial statements: balance sheet, income statement, and cash flow statement. 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 value and financial position in terms of the company's assets, total liabilities, and even projected earnings. When evaluated along with the other financial statements, a balance sheet provides a view of the company at a specific point in time. The income statement, balance sheet, and cash flow statement offer financial analysts a clear snapshot of a company's financial position at a specific point in time from which to project future shareholders equity. After all, no firm maintains financial health without a clear accounting of the books.

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 at a specific point in time, including assets, liabilities, and material events at the end of a fiscal period. Frequently, figures from previous periods are displayed along with the current numbers as as way to account for fluctuations in shareholders equity. This way, investors can measure the company's assets, relative growth, and overall valuation. Furthermore, shareholders use a balance sheet as a tool for measuring liabilities and shareholders' equity. When analysts assess all of the financial statements they can arrive at a sound assessment of the company and its place in the market.

What Does the Balance Sheet Cover?

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Assets

On the balance sheet, assets are a chief part. The company's current 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 on hand as a liquid asset 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 as part of the firm's current assets. Often public SEC filings discuss the facts behind the balance sheet. That's where accountants discuss possible shortfalls from delinquent accounts or a net positive when fees and interest accrues on overdue accounts.
  • Inventory/Supplies/Land/Equipment: These assets are physical objects that can be sold for cash. Their value, including depreciation, is accounted on the balance sheet as part of the firm's current assets. Inventory is valued as a current asset on the balance sheet, according to its cost to the company or its market value, whichever is lower. Purchasing such capital investments is accounted on the balance sheet, and discussed in a prose fashion on SEC filings.
  • 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 on the balance sheet and dividends can appear on the cash flow statement. Some investments, such as money market funds or securities that are intended for liquidation, an accountant often reports their estimated value on the firm's balance sheet.
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Liabilities

Liabilities include all funds that are owed to third parties as short or long term debt. These debits are recorded on a company's balance sheet. Taxation is a type of liability, as is a line of credit. Like investments, these debts are considered either long-term liabilities or short-term. A short-term liability should be paid off within a year and long-term debts 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 listed with the long-term debits.

  • Debt: This is money owed to creditors for a range of items. Companies might accrue long term debt in order to finance more inventory or to fund research. Though debt is often thought of as negative, it does offset profits and thus taxation. Long-term shareholders equity is often protected with debt securities. In fact, since some debt can be sold on the market, one of these current liabilities could turn into one of the firm's long term assets.
  • 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. This figure is often called accounts payable and is a large part of a firm's financial health.
  • Rent: Since many companies don't own the property where they do business, their facilities are accounted as accounts payable on the balance sheet, and as long-term liabilities. However, some companies will pre-pay rent and then account for it on each subsequent month's income statement. Since rent is a fixed cost for the terms of a lease, it can be predicted when calculating shareholders equity.
  • Tax: Taxation is a reality for all companies and this liability must be accounted for on the balance sheet. Clever accountants strive to reduce this part of a company's overall current liabilities. Tax is often due within one year, else added fees (liabilities) accrue.
  • 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. In cases where companies have installed solar panels, their utilities may convert from accounts payable to receivables.
  • Wages Owed: Companies must pay their employees each pay period and list payroll expenses as part of a company's current liabilities. Then there are other compensation issues including commission checks, bonus packages, and even benefits packages. This sort of liability must be paid immediately, and certainly within a year. Bonus payments might be put off, but employees will want their checks within one year.

Owner’s/Shareholder’s Equity

The liabilities and shareholder’s equity in any company are balanced and calculated as part of the net assets or net worth of a company, which is helpful in calculating the company's overall net value and financial position. 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 including the total assets and current liabilities. 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 statement of financial position, 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 financial position, including its current liquidity and current liabilities. 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. Though reducing liabilities and shareholders' equity is a top priority, the balance sheet should be solidly in the black every quarter.

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-over-year balance sheets as a way to seek trends or patterns. In fact, financial analysts will pull the balance sheet, along with the other required financial statements, from each SEC filing a company has made for the previous three years or so. Sometimes, the quarterly balance sheet provides more detail, but the balance sheet and other annual financial statements are often sufficient. 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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