Along with the income statement and cash flow statement, balance sheet is one of the most important statements of a company. Also referred as the statement of financial position, it contains information about company’s total assets, liabilities and shareholders’ equity as of the date stated. The information from the balance sheet is commonly used for performing the analysis of company’s liquidity, financial sustainability and other indicators.
Main information indicating firm’s financial condition as of the date stated can be found in its balance sheet. It summarizes company’s debts and assets, and the stockholders’ equity. Actually, whole balance sheet is based on one simple equation:
Assets = Source of Finance (Liabilities + Stockholders’ Equity)
As creditors’ and company owners’ funds are two main sources of financing company’s assets, at any time firm’s assets must equal the sum of its liabilities and equity.
Assets are the resources of a company, including physical resources, such as buildings, materials, equipment, etc.; and also intangible, such as trademarks, or patents. Normally, assets are categorized into current (also referred as short-term) and noncurrent (long-term).
Current are assets, which can by expectations be converted to cash within one operating cycle (or year). Often their listing in the balance sheet is being made in order of their liquidity.
1. Cash (and its equivalents).This is an asset with the highest liquidity. Treasury bills, bank deposits, and other money market instruments are also included in this entry of the statement of financial position.
2. Accounts Receivable. This entry summarizes the amount of money, which a company has a right to receive for providing its customers with goods or services. The amount reflected commonly only includes the amount of money that is expected to be collected. Long overdue or uncollectible accounts are not shown in this entry of the balance sheet.
3. Inventories. Inventories include materials for production, work-in-progress products, and ready products that the company is planning to sell in future. Supplies like pencils, envelopes, folders are also included in inventories.
4. Marketable Securities. This is the entry, where short-term investments with a very high level of liquidity are listed. The reason for holding marketable securities for a firm is earning a return on near-cash resources.
5. Other current assets. All other assets, convertible into cash within a business cycle, or a year (prepaids, etc.).
Noncurrent are assets, which take longer than an operating cycle to be converted to cash and they include:
1. Buildings and equipment. This type of assets is also classified, as fixed assets. They include buildings, land, machinery, constructions in progress and all the other tangible assets, which are owned by a company and being used in goods or services production process from one business cycle to another.
2. Intangible Assets. This is a type of noncurrent assets in company’s ownership that aren’t in physical form and their conversion to cash takes longer than a business cycle (or year). These assets include patents, copyrights, trademarks, licensing agreements, franchises and others.
3. Long-Term Investments. These are such kind of investments, as bond or preferred stock, which are made for a period over 10 years. The main difference between them and short-term investments is liquidity level. While short-term investments are relatively easily convertible to cash, long-term investments are difficult to sell.
4. Other noncurrent assets.
Liabilities are reflected in company’s balance sheet obligations to provide goods or services, or transfer assets to other firms. Being a result of the past transactions, firm’s liabilities are also divided into current liabilities and long-term liabilities.
Current liabilities are obligations due within one business cycle (or year). The liquidation of current liabilities most likely would require the use of company’s current assets, or creating other current liabilities by involving some short-term loans. Following items are included:
1. Accounts Payable. These are accounts, which were created by the acquisition of some goods or services and should be paid by a company in the near time.
2. Unearned Income. Unearned income includes money received in advance of selling a good or providing a service.
3. Other current liabilities.
Long-term liabilities are obligations due in a period more than a year, or alternatively, more than a business cycle. Balance sheet includes such kinds of long-term liabilities, as notes payable, bonds payable, capital lease obligations, postretirement benefit obligations, etc. Normally, they are classified as liabilities relating to financing agreements and operational obligations:
1. Financial agreements relating liabilities. This kind of liabilities include notes payable, bonds payable, credit agreements. These obligations most commonly require making regular payments of interest.
2. Operational obligations relating liabilities. These are obligations, connected with the operational activity of a firm. Most common kinds of operational obligations relating liabilities are pension obligations, deferred taxes, service warranties, etc.
Stockholders’ equity (also very often being referred as net worth, or shareholders’ equity) is an amount, representing shareholders’ interest in firm’s net assets. In other words, it shows the amount of money, by which a firm is being financed through the common and preferred stock. By applying some minor changes to the basic balance sheet equation we receive a formula for stockholders’ equity computation:
Stockholders’ Equity = Total Assets – Total Liabilities
There are two main sources of shareholders’ equity. First is the paid-in capital, which includes all the investments into the company that have been made, originally at the very beginning and additionally thereafter. Retained earnings are the second source of the shareholders’ equity, and they include all the earnings, that the company has been able to accumulate through its operations.
Paid-in capital is the total amount of money that has been invested into company during the issuances of common or preferred stock. While common stock represents ownership, having the rights of voting and liquidation, preferred stock usually do not have such rights. Main important decisions on the company, including electing the board of directors, are usually being made by the holders of common stock.
Paid-in capital may also include donated capital. It includes donations from stockholders, creditors, and other parties.
Retained earnings represent that part of net earnings, that aren’t being distributed by a company between the investors as dividends, but are being reinvested into business again, or into debts pay off. The formula for retained earnings calculation is as follows:
Retained Earnings = Beginning Retained Earnings + Net Income – Dividends
All the necessary information for calculation is available in company’s balance sheet. Negative net income (net loss) would mean negative retained earnings.
Balance sheet is one of the primary statements of an enterprise. It includes full information on company’s assets, liabilities and stockholders’ equity, which can be used for the performance of liquidity analysis, financial sustainability analysis and other kinds of indicators, measuring firm’s performance and position. For every balance sheet company’s assets must be equal to its sources of finance (liabilities plus stockholders’ equity).