Understanding the Balance Sheet

Welcome to my regular accounting and finance blog. Today is October 11, 2018.

My blogs are designed to teach basic accounting and financial concepts that everyday people can apply to their financial and business lives. With each blog I will explain an accounting or financial concept in general terms. I will start with easy topics, and move on to more complex topics over time.

Today’s topic is “Understanding the Balance Sheet.”

Most financial statements include a balance sheet, an income statement, and a statement of cash flows. In this blog I will discuss the balance sheet.

The balance sheet shows a company’s assets, liabilities and equity at a specific point in time, usually at the year-end or at a month-end. All the numbers on a balance sheet show a specific static measurement at that point in time, as opposed to the income statement and cash flow statement which measure operations over a period of time.  It is called the balance sheet as it should always be in balance – Assets = Liabilities + Equity. Another way of looking at this is Assets – Liabilities = Equity.

The top part of the balance sheet shows the company’s assets, or what it owns.  Assets are usually grouped into “Current Assets,” which can generally be turned into cash and used by the business within a year, and “Long-term Assets,” such as fixed assets (buildings, equipment, vehicles, etc.) which will be held by the company for periods past one year.

Current assets include:

  • Cash,
  • Short term investments,
  • Accounts receivable,
  • Other receivables,
  • Inventory, and
  • Prepaid expenses.

These assets are usually ordered accordingly to how quickly these items can be turned into cash. For example, accounts receivable is usually always shown before inventory.

Long-term assets are usually fixed, or capital, assets.  They include such owned assets as land, buildings, fixtures, machinery and equipment, and vehicles.  Each of these are amortized over their useful life, resulting in an annual amortization, or depreciation, expense on the income statement.  The total amortization to date is shown in long-term assets as “Accumulated Amortization.”

Next on the balance sheet is liabilities. Liabilities, like assets, are grouped as “Current Liabilities,” which are payable within one year, and “Long-Term Debt,” which are payable over longer periods of time.

Current liabilities include:

  • Accounts payable,
  • Accrued liabilities,
  • Employee deductions payable,
  • Taxes payable, and
  • Borrowings or loans due within one year.

Long-term debt usually includes mortgages payable and other long-term loans, usually with fixed payment terms over a period of time.

The last item on a balance sheet is Equity. Equity for corporations includes capital stock issued and retained earnings (accumulated income to-date.)  Equity for sole proprietors and partnerships usually includes earnings to-date, plus owner contributions to-date, less owner drawings to-date.

The balance sheet is related to the income statement as profits and losses over a period of time affect the equity balances, with offsetting changes in both assets and liabilities. For example, a profit for the year will usually show as an increase in current assets, or a decrease in current liabilities, or a combination of both, with an offsetting increase in equity. A loss for the year will have a negative affect on these balance sheet items.

 


I hope you will enjoy my blogs and find them useful. My next topic will be “Understanding the Income Statement.”  Please drop by.

 

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