Accounting 101 – The Balance Sheet
The balance sheet (sometimes called a statement of financial position) provides a snapshot of the financial status of a company at a particular point in time. This financial statement details your assets, liabilities and equity, as of a particular date. Although a balance sheet can coincide with any date, it is usually prepared at the end of a reporting period, such as a month, quarter or year.
Because the balance sheet informs the reader of a company’s financial position as of one moment in time, it allows someone—like a creditor—to see what a company owns as well as what it owes to other parties as of the date indicated in the heading. This is valuable information to the banker who wants to determine whether or not a company qualifies for additional credit or loans. Others who would be interested in the balance sheet include current investors, potential investors, company management, suppliers, some customers, competitors, government agencies, and labor unions.
The balance sheet consists of 3 major components or categories:
- Assets
- Liabilities
- Owner’s Equity
Assets
Assets are the things the company owns. Your assets include concrete items such as cash, inventory and property and equipment owned, as well as marketable securities (investments), prepaid expenses and money owed to you (accounts receivable) from payers. Assets also include intangibles of value, like patents or trademarks held.
Assets are categorized as either current or non-current, based on how quickly they are expected to be turned into cash, sold or consumed.
Current or short-term assets, such as cash, accounts receivable, inventories, prepaid expenses and short-term investments, are items your business has acquired over time that are expected to be converted into cash within one year, or one business cycle, of the date on the balance sheet.
Non-current or long-term assets are any fixed assets or items your business owns. Things that fall into this category are office equipment, building property, land, long-term investments, stocks, and bonds. These are items that the company expects to own for more than a year and are not easily liquidated.
Liabilities
Liabilities reflect all the money your company owes to others, and they usually have the word “payable” in their account title. This includes amounts owed on loans, accounts payable, wages, taxes and other debts. Liabilities also include amounts received in advance for future services. Since the amount received (recorded as the asset Cash) has not yet been earned, the company defers the reporting of revenues and instead reports a liability such as Unearned Revenues or Customer Deposits.
Similar to assets, liabilities are categorized based on their due date, or the time frame within which you expect to pay them. Just like assets, there are current and non-current liabilities.
Current liabilities represent payment obligations your company has to pay within 12 months of the date on the balance sheet.
Non-current liabilities are amounts your company has more than one year to pay. Bondholder and bank debt are considered non-current liabilities.
Owners Equity
Owner’s Equity, along with liabilities, can be thought of as a source of the company’s assets. Owner’s equity is sometimes referred to as the book value of the company, because owner’s equity is equal to the reported asset amounts minus the reported liability amounts. Owners’ equity can also be referred to as the company’s net assets or net worth because it represents the assets that remain after deducting what you owe. Owner’s equity is viewed as a residual claim on the business assets because liabilities have a higher claim. In simplified terms, it is the money you would have left over if you sold your practice and all of its assets and paid off everything you owe.
If you are the sole proprietor of your business, this is referred to as owner’s equity. If your business is a corporation, equity is called stockholder’s or shareholder’s equity instead of owner’s equity.
For a sole-proprietor the basic components of owner’s equity are:
- Owner’s Investment
- Plus: Owner’s Contributions
- Less: Owner’s Draws or Withdrawals
- Plus: Net Income (or minus Net Loss)
For a corporation, the basic components of stockholders’ equity are:
- Paid-in Capital
- Retained Earnings
- Accumulated Other Comprehensive Income
- Treasury Stock
Equity is made up of paid-in capital and retained earnings. Paid-in capital is the amount each shareholder initially paid for his or her stock. Retained earnings refers to the amount of money your business didn’t sell to shareholders and instead reinvested into itself.
Owner’s Equity vs. Company’s Market Value
Since the asset amounts report the cost of the assets at the time of the transaction—or less—they do not reflect current fair market values. Since the assets are not reported on the balance sheet at their current fair market value, owner’s equity appearing on the balance sheet is not an indication of the fair market value of the company.
