The Balance Sheet

companies prepare balance sheets as a means of summarizing their financial positions at a given point in time.


Most people go to a doctor once a year to get a checkup--a snapshot of their physical well-being at a particular time. Similarly, companies prepare balance sheets as a means of summarizing their financial positions at a given point in time.


Assets = liabilities + owner's equity


Assets are the things a company invests in so that it can conduct business--examples include financial instruments, land, buildings, and equipment. in order to acquire necessary assets, a company often borrows money from others or makes promises to pay others. That money, which is owed to creditors, is called liabilities. Owners equity, also know as shareholders' equity, includes the capital that investors have provided and the profits retained by the company over time. If a company has $3 million in assets and $2 million in liabilities, it would have owners' equity of $1 million.


Assets = liabilities + owner's equity
$3MM = $2MM + $1MM


By contrast, a company with $3MM in assets and $4MM in liabilities would have negative equity of $1MM--and serious problems as well.


Thus, the balance sheet provides a description of how much, and where, the company has invested (its assets)--broken down into how much of this money comes from creditors (liabilities) and how much comes from stockholders (equity). Moreover, the balance sheet gives you an idea of how efficiently your company is utilizing its assets and how well it is managing its liabilities.


Balance sheet data is most helpful when it's compared with information from a previous year. The balance sheet begins by listing the assets that are the most easily converted to cash: cash on hand, receivables, and inventory. These are called current assets.


Next, the balance sheet tallies other assets that have value but are tougher to convert to cash--for example, buildings and equipment. These are called fixed or long term assets.


Since most long-term assets, except land, depreciate over time, the company must also include accumulated depreciating in this part of the calculation. Gross property, plan, and equipment minus accumulated depreciation equals the current book value of property, plant, and equipment.


Subtracting current liabilities form current assets gives you the company's working capital. Working capital gives you an idea of how much money the company has tied up in operating activities. Just how much is adequate for the company depends on the industry and the company's plans.


Most long term liabilities are loans.


Owner's equity comprises retained earnings (net profits that accumulate in a company after any dividends are paid) and contributed capital (capital received in exchange for stock).



ACTION POINT: Become familiar with the key components of the balance sheet to evaluate the health of your organization.