Balance Sheet

Balance sheet is one of three main financial statements and reports a company's assets, liabilities, and owner's equity. Learn more about this statement, review examples, and learn common balance sheet ratios.

What is the Balance Sheet?

There are three fundamental financial statements for businesses: income statement, balance sheet, and cash flow statement. The balance sheet shows a business’s assets, liabilities, and owner’s equity for a specific moment in time. It is the basis for a number of core accounting principles, values, and ratios.

The balance sheet formula is total assets = total liabilities + total owner’s equity. In other words, all of the productive assets of a business must be financed by their liabilities (e.g., debt) or the owner’s equity (e.g., profit or capital contributions).

In this post, we are going to explore the balance sheet, where its name is derived from, examples of balance sheets, how to properly analyze a balance sheet, and common ratios that rely on the balance sheet.

As with the other financial statements, U.S. companies conform their balance sheets to the Generally Accepted Accounting Principles (GAAP) standards.

The balance sheet is one of three primary financial statements. The balance sheet formula is total assets must equal total liabilities plus total shareholders' equity.

Balance Sheet Accounts

The balance sheet is made up of different line items. All businesses will have a basic set of accounts (like cash, current assets, and current liabilities), whereas other accounts will be very specific to a particular type of business or industry (like deferred revenue for companies with subscription revenue).

A balance sheet account is a descriptive subcategory that goes beyond the basic categorization of asset, liability, or equity.Since account values will fluctuate day-by-day (e.g., when you pay a bill with cash on hand, your cash balance will drop), all of the accounts are listed as of a specific date. The most common dates are the end of the month, quarter, or the fiscal year.

As with other financial statements, one account could have multiple names that are commonly used to describe it. For instance, long-term liabilities could also be called long-term debt or non-current liabilities.

Here are a few examples of balance sheet accounts…

Cash = Legal tender and currency; examples include bills, coins, checking accounts, savings accounts, petty cash, money orders, and checks.
Cash Equivalents = Investment-grade securities that have high credit ratings and are highly liquid; examples include commercial paper, Treasury bills (T-bills), certificates of deposits (CDs), money market instruments, and marketable securities.
Accounts Receivable = Money owed to a company by its debtors; examples include invoices sent with a net 30 day payment term
Prepaid Expenses = Amount paid for goods or services in advance of receiving it; examples include prepaying for insurance for the year or paying an annual software contract at the beginning of the term
Accounts Payable = Money that a company owes to its creditors or vendors; examples include invoices from vendors, suppliers, or partners
Credit Card Expense = Amount paid for goods or services in advance of receiving it; examples include prepaying for insurance for the year or paying an annual software contract at the beginning of the term
Current Liabilities = Payments to vendors and creditors that must be repaid within 1 year; examples include interest payable, wages payable, taxes payable, and the current portion of long-term debt
Long-Term Liabilities = Payments to vendors and creditors that must be repaid 1 or more years from now; examples include bonds payable, long-term loans, capital leases, and deferred revenue
Shareholders’ Equity = The net worth of a company, or the amount that would be repaid to shareholders if the company’s assets were sold and its debts were repaid

Balance Sheet Formula: Assets = Liabilities + Equity

The balance sheet formula explains how the balance sheet accounts must balance out. The formula is total assets = total liabilities + total owner’s equity. Let’s walk through this formula in more detail below.

Assets are resources with economic value that a company owns. Assets are broken into two main categories: current assets are expected to be used or sold within one year or the business’s operating cycle, and fixed assets have a useful life beyond one year.

Let’s take the example of an ecommerce business. Their assets would include cash, cash equivalents, accounts receivable, inventory, trademarks, and more. In simple terms, the business relies on selling inventory for a markup and using their cash to pay bills, perform marketing activities, and pay employees.

How does a business fund these assets? There are only two ways: liabilities or equity. As a result, this is the opposite side of the balance sheet formula.

Liabilities are obligations that a company has to pay back. Examples include credit card payments, wages payable, short-term debt, long-term debt, and more.

Equity is the owner’s claim to the business. Equity could be paid for by issuing stock (e.g., an investor invests $100,000 into a business in exchange for a 25% stake) or equity could build through profitable operations.

Whether you are a business owner thinking about your own balance sheet or an investor evaluating a public company, understanding how a company’s assets are funded will help you form an understanding of the business’s financial viability and stage.

Balance Sheet Example

Here are two balance sheet examples that we will analyze. Company A has a simple balance sheet with summary-level information only.

Company A, Fiscal Year 2021

Current Assets: $3,500,000

Fixed Assets: $6,800,000

Current Liabilities: $2,800,000

Non-Current Liabilities: Unknown

Shareholders’ Equity: $2,000,000

Let’s take these values and build a complete balance sheet.

B/S: Total Assets = Total Liabilities + Total Shareholders’ Equity

B/S: $3,500,000 + $6,800,000 = $2,800,000 + x + $2,000,000

B/S: $10,300,000 = $4,800,000 + x

x = $5,500,000

For Company A, we know their non-current liabilities are $5,500,000. Now that we solved for the missing value, we can show that we have the correct answer by using the balance sheet formula.

B/S: Total Assets = Total Liabilities + Total Shareholders’ Equity

B/S: $3,500,000 + $6,800,000 = $2,800,000 + $5,500,000 + $2,000,000

B/S: $10,300,000 = $10,300,000

Company B has more account types and some subaccounts. But we can use the information above to still understand and analyze this statement. Our task for Company B is to calculate shareholders’ equity.

Company B, Fiscal Year 2021

Cash: $100,000

Cash Equivalents: $220,000

Goodwill, Patents, and Copyright: $150,000

Credit Cards: $36,000

Short-Term Debt: $150,000

Long-Term Debt: $200,000

First, we need to sum up the current and non-current assets to get total assets. Remember that goodwill, patents, and trademarks are intangible assets and need to be factored in.

Assets = Cash + Cash Equivalents + Goodwill

Assets = $100,000 + $220,000 + $150,000

Assets = $470,000

Second, we need to find the total liabilities.

Liabilities = Credit Cards + Short-Term Debt + Long-Term Debt

Liabilities = $36,000 + $150,000 + $200,000

Liabilities = $386,000

Now, we can use the balance sheet formula to find the total equity.

B/S: Total Assets = Total Liabilities + Total Shareholders’ Equity

B/S: $470,000 = $386,000 + Total Shareholders’ Equity

B/S: $84,000 = Total Shareholders’ Equity

B/S: $10,300,000 = $10,300,000

For Company B, the equity value was $84,000 for 2021.

How to Analyze a Balance Sheet

The balance sheet serves multiple purposes, from understanding the capital structure of a business to getting a better sense of how a firm generates profit.

When analyzing a balance sheet, there are a few key areas to look at…

Liquidity & Solvency: In order to stay in business, companies will need to have enough cash and current assets on hand to cover its short-term obligations (liquidity) and enough long-term assets to cover its long-term obligations (solvency). If a company cannot meet these standards, then the viability of the business or of its capital structure should be called into question. Liquidity ratios like quick ratio and current ratio can sound the alarm bells. If these ratios are too high, they should give you pause.
Operational Efficiency: Assets are used to create an economic profit, so it’s helpful to compare a company’s assets to their income and profit. An efficient use of assets can be the difference between profitable growth and struggling to get your feet under you. Efficiency ratios like inventory turnover, asset turnover, and days accounts receivable provide a view into operational efficiency.
Leverage: Leverage refers to the amount of debt that is employed in order to increase financial returns. One risk is that a firm has small profits on its income statement and uses a high degree of leverage to increase its returns. Digging into the balance sheet can help you answer these questions. Leverage ratios like debt/equity and debt/capital are helpful tools, particularly when used every month to make sure that a company has not taken too much debt recently.

Looking at a firm in isolation can tell you about their financial viability at that moment. However, like the other accounting statements, it can be helpful to look at a few sequential periods (month over month or quarter over quarter) to understand the trends of their business.

Moreover, you can use a company’s balance sheet to understand their cash position, profitability, and leverage compared to competitors.

In short, this statement will explain the assets a company has and how those assets were paid for. You will want to look for a company that has a secure financing structure and that liabilities, like loans, lines of credit, and leases, are taken out in order to generate a positive return.

Common Balance Sheet Ratios

There are plenty of financial ratios that are calculated based on balance sheet accounts or a combination of income statement and balance sheet values. Here are a handful of the most common balance sheet ratios:

Final Thoughts

Small business owners, accountants, managers, investors, and creditors will all look to the balance sheet in order to understand the health of a business.

As mentioned above, the statement shows account balances at a specific point in time, so the balance sheet is always a snapshot of how a business looked on that particular day.

The balance sheet formula is total assets = total liabilities + total owner’s equity. Moreover, understanding the relationship between assets, revenue, and profit can show you if a company is well managed or poorly managed.

Companies finance assets in one of two ways, through liabilities or through equity. While taking debt on is not necessarily a bad thing, there should be a clear plan in place when taking on debt and investing in long-term assets. A bad sign is that assets and liabilities keep ballooning on the balance sheet, but revenue and profit on the income statement are stagnate.

Whether you are a business owner, manager, or lender looking to underwrite a loan, the balance sheet is a powerful financial statement that is full of useful information. Not to mention, there are plenty of liquidity, efficiency, and leverage ratios that can be derived from balance sheet values.

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