Balance sheet is one of the most important financial statements. To understand a balance sheet better, let us take a look at the elements of their balance sheet. As you can see, the balance sheet shows all assets on top, and then all liabilities and shareholder’s equity below the assets. This style of presentation is called report form or vertical presentation. Alternatively, balance sheet an also be presented in a horizontal formation in which the assets will be shown on the left side, and liabilities and equity will be shown on the right hand side. In a balance sheet, the total assets will always be equal to the sum of liabilities and shareholder’s equity.
We will now look at the key elements on both sides of the balance sheet.
Asset Side of Balance Sheet
Assets are what the company owns, and this section of the balance sheet tells you what kind of assets the company owns, and the value of those assets.
The assets can be broadly classified into current assets and property, plant and equipment.
Current Assets
Current assets include cash, accounts receivable, marketable securities, inventory, and prepaid expenses such as taxes and insurance. These are the assets that can be converted into cash in the near future, usually less than one year.
- Cash and Cash-equivalents – The first kind of current assets are the most liquid – cash or cash equivalents. Next are marketable securities, which are short-term investments that can easily be transitioned to cash.
- Accounts receivable – This refers to money due to the company from sales to customers.
- Inventory – This is an investment that the company has made in the manufacture and production of goods.
- Prepaid expenses – These are expenses the company has paid ahead of time. This could include rent, payment on leases, or other expenses paid ahead of time.
Property, Plant, and Equipment
- Property, plant, and equipment – These include the land, building, machines, equipment, and furniture, which are valued at the purchase price or original market value, whichever is lower.
- Depreciation – Depreciation is an important consideration for assets that fall in the category of property, plants, and equipment. Depreciation means the apportionment of the cost of these assets over their useful lives. The accumulated depreciation is the amount that has been recorded as depreciation expense since the date the asset was purchased. The balance in the accumulated depreciation account is deducted from the original cost of the fixed assets.
Assets on a balance sheet can be shown in several ways:
- Total current assets – These are calculated by adding current assets: cash and marketable securities, accounts receivable, inventory, and prepaid expenses.
- Land, building, and machines – By adding the cost of the land, building machines, equipment, and furniture, you get the cost of property, plant, and equipment.
- Accumulated depreciation – The accumulated depreciation is subtracted from the cost of property, plant, and equipment. This is the cost less depreciation to date.
- Total assets figure – The total current assets plus cost less depreciation equals total assets.
The assets section of the balance sheet provides you with a big picture overview of the financial health of the company. By understanding the balance sheet, you’ll understand how much money the company has.
Liabilities Side of Balance Sheet
The liability side of the balance sheet tells you how much money the company owes. Types of liabilities include:
Current Liabilities
- Accounts payable – These are the bills for which the company owes money to vendors or suppliers. This includes operating expenses and inventory. The company has bought these services on credit. The money is generally due within 30 to 60 days.
- Bank notes – These are money the company has borrowed from a commercial lender, such as a bank. The money must be repaid to the bank within one year.
- Other current liabilities – These are short-term liabilities, usually accruals. Companies always owe employee salaries, interest, and taxes. Unpaid expenses are estimated and listed as accruals.
- Current portion of long-term debt – The current portion of long-term debt are the current liabilities that were originally long-term debts when the company originally borrowed the money. However, time has passed, and the amounts listed in the section are due in less than a year.
- Total current liabilities – This is the sum of accounts payable, bank notes, other current liabilities, and the current portion of long-term debt. The total current liabilities are due within one year of the date of the balance sheet.
Long-term debt
This refers to money the company borrowed that is a long-term loan. The loan matures anywhere from just over a year to thirty years. There are a variety of ways to fund this debt – debentures, mortgage bonds and convertible bonds. It can also include tax liabilities.
Stockholders’ equity
This is the amount of money owners have invested in the business. It is divided into preferred stock, common stock, and retained earnings. Stockholders receive dividends when there is a profit, or they can reinvest earnings, which are called retained earnings.
These are the types of liabilities that are listed on the balance sheet. Understanding these liabilities helps you see what kind of debt the company is carrying.