The Balance SheetThe Balance Sheet

Elements of a Balance Sheet

A balance sheet, also called the statement of financial position, lists:

• Assets

• Liabilities

• Owners Equity

as of a specific date. It gives an idea of what the company is worth.

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Elements of a Balance Sheet

AssetsAssetsAssets are all those things a company owns which are of value to the business.

Assets can be tangibletangible like e.g. a manufacturing plant, computers or cash in the bank.

Tangible assets like cash or goods for sale that can easily (i.e. within an accounting year) be converted into cash are called current assetscurrent assets while other assets like properties and equipment are called fixed assetsfixed assets.

Assets can also be intangibleintangible (meaning cannot be touched) such as copyrights or goodwill.

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Elements of a Balance Sheet

LiabilitiesLiabilities

Liabilities are all those things for which the company eventually needs to pay. There are two types of liabilities:

Current LiabilitiesCurrent Liabilities need to be paid within one accounting year. Examples are: Outstanding rent, goods bought on credit.

Long Term LiabilitiesLong Term Liabilities are those liabilities which will not be paid during the current accounting year. Examples are: Long term debts, bank loans.

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Elements of a Balance Sheet

Owner’s EquityOwner’s Equity

Owner’s EquityOwner’s Equity is by definition the difference between the Assets of a company and its Liabilities. Owner’s Equity is the sum of two parts:

Contributed CapitalContributed Capital is the money that the owners invested in the company.

Retained EarningsRetained Earnings are those earnings which were not distributed to the owners. These can accumulate to a large sum over the years.

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Elements of a Balance Sheet

Remember: A Balance Sheet must balance the assets, liabilities and owner’s equity.

Assets – Liabilities = Owner’s Equity

Most commonly, the assets are on top and the liabilities and owner’s equity on the bottom.

Let’s now have a look at a balance sheet.

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A Simple Balance Sheet

Completing a Balance Sheet

Elements of a Balance Sheet

Assets – Current Assets

Cash and Cash Equivalents

• Cash is all the cash the company has, be it in bank accounts or in the cash box.

• Cash EquivalentsCash Equivalents are short term investments that can be converted to cash with no or very little delay. Examples of Cash Equivalents are: Money Market Investments, Government Bonds.

Accounts Receivable• Most businesses do not immediately receive payment for (some or all)

of the goods or services they sell. Assuming that payment will indeed be made in the near future, a receivable account is an asset.

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Elements of a Balance Sheet

Assets:Total Current Assets

In this case, of course, its just the sum of ‘Cash and Equivalents’ and ‘Accounts Receivable’, but there could be many more ‘current’ items.

Total current assets is an important item since it indicates how much money the company has to run its business.

Elements of a Balance Sheet

Assets: Fixed Assets

Plant and EquipmentIn order to run a business one usually will need to buy some equip-ment (even when one is in the service business) like e.g. machinesand computers. The total cost price of the bought equipment is listedin this item (note, the fact that equipment becomes worth less isaccounted for in the next item).

Accumulated DepreciationNaturally, when one uses equipment it will get old and thus become worth less. It is therefore necessary to subtract a certain amountfrom the original equipment value every year. Since one would liketo keep the original value listed above, one needs to ‘accumulate’i.e. sum up all the previous year’s depreciations.

Elements of a Balance Sheet

Assets: Net Fixed Assets

In this case the net fixed assets are ‘Plant and Equipment’ minus ‘Accumulated Depreciation’, but there could be many more items.

Note that having a lot of fixed assets does not necessarily mean that the company is ‘rich’. It is also important to realize that fixed assets do not provide cash for running the business (though they could be use as collateral for a loan).

Elements of a Balance Sheet

Assets: Total Assets

Total Assets = Current Assets + Net Fixed Assets

Note: While total assets in a sense represent the current value of the business, they do not necessarily represent the resale value or the liquidation value of the business.

The total assets are the value of the business as seem from the perspective of a continuation of the currently operating business.

Elements of a Balance Sheet

Liabilities: Current Liabilities

• Accounts PayableJust as there are accounts receivable, there are also accountspayable. Businesses usually do not need to pay immediately upondelivery but have e.g. 30 or 60 days ‘credit-terms’.In other words, ‘accounts payable’ are unpaid bills due soon.

• Other Current LiabilitiesAll the liabilities which are due within one accounting year andwhich are not separately listed (in this case only accounts payable)are lumped together here. Examples are: unpaid salaries, interest,short term loans.

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Elements of a Balance Sheet

Liabilities: Total Current Liabilities

The total current liabilities are an important indicator of how much money a company will need in the near future.

If the total current liabilities are much bigger than the total current assets great caution is warranted.

Elements of a Balance Sheet

Liabilities: Long Term Liabilities

• Long Term DebtWhile in daily life having debts (especially credit card debts!) isusually not a good thing, the proper use of long term loans is anessential part of many business activities. It is for example veryrare that a company has enough cash to build a new state of the artmanufacturing plant. The idea is of course that you earn more thanyou pay in interest. (This is somewhat similar to buying a condowith a mortgage).

• Other Long Term LiabilitiesAll other liabilities which do not need to be returned within oneaccounting year and which are not separately listed. E.g. Royalties,asbestos claims.

Elements of a Balance Sheet

Liabilities: Total Liabilities

Total Liabilities = Total Current + Long Term Liabilities

Note: If the Total Liabilities exceed the Total Assets, the company is almost certainly in some sort of danger. But there are exceptions to this! (Especially companies in new hot industries like e.g. dot.coms or genetics).

Elements of a Balance Sheet

Liabilities: Owner’s or Shareholder’s Equity

• Common StockWhen a corporation is set up or when it needs money and desires todo so, it can issue common stock. The amount received is enteredunder this item. Note that the value printed on the stock certificatemay be quite different from what one actually pays.

• Retained EarningsAt the end of an accounting year, a company can have a profit ora loss. The profit or loss (in case of loss, naturally with a minussign) is added to the retained earnings.The retained earnings sum up all the profits and losses since theinception of the company (minus paid out dividends).

Elements of a Balance Sheet

Liabilities: Total Owner’s or Shareholder’s Equity

This is the amount the company ‘owes’ its shareholders.

Note that from an operational point of view, these debts have no impact on the daily running of the business since they do not need to be repaid.

Elements of a Balance Sheet

Liabilities: Total Liabilities and Owner’s Equity

As such this item is mainly a cross check for the accuracy of the balance sheet. It must be exactly the same number as the total assets or something is wrong!

Key Points of the Day

The Balance Sheet provides a snapshot of the assets and liabilities of a company.

The Balance Sheet is one of the most important financial statements.

Remember:

Assets – Liabilities = Owner’s Equity

And again:

Assets – Liabilities = Owner’s Equity

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