The balance sheet presents the assets, liabilities and equity at the end of the most current and previous reporting periods. It is built on the fundamental accounting equation (assets equal liabilities and equity) and provides the structural integrity for the financial statements. The liabilities and equity items provide the funds (sources of funds) which are invested in assets (uses of funds), and many professionals refer to the balance sheet as a sources and uses statement. The statement provides a snapshot of a company’s financial position (shown below).
There are variations in the details of how balance sheets are presented, especially globally, but the fundamentals are the same. The assets are listed in order of liquidity; so, cash and cash equivalents appear at the top while the last asset listed is intangibles and other assets.
The most common presentation follows the accounting equation, with assets first, followed by liabilities and equity. This format is illustrated in the above statement. Some businesses rearrange the equation to show assets – liabilities = equity.
The assets and liabilities are further divided into current and non-current. If expected to turn into cash or be discharged in less than one year then they are classified as current. If this is expected to be longer than one year they are classified as non-current.
Historical Cost Basis
The statement provides a historical record of past transactions and their impact on assets, liabilities, and equity. This means that the amounts shown are unlikely to approximate market values. If the asset was purchased on the balance sheet date, then it may well be market value, but it might have been purchased many years earlier.
For many assets, decreases in their value are recorded, whereas increases are not. Inventory for example, is recorded at cost initially even though the resale value is expected to be higher than cost. However, if it is expected that the inventory will need to be sold at a loss, then the amount on the balance sheet will be written down to the expected recoverable amount.
Common Items Found in the Balance Sheet?
The statement comprises of assets, liabilities and equity. There are many items which fall into one of the three categories and these are shown below:
Assets – Cash and Cash Equivalents
Includes cash and highly liquid assets with a short term to maturity (usually 90 days). This item is always categorized as a current asset.
Assets – Short Term Investments
There are marketable securities which can be very quickly converted to cash. A company with a surplus of cash may purchase these short-term financial assets.
Assets – Inventories
This line item represents the purchase price of goods held for resale. In a production-based business the inventory is made up of raw materials, work in progress and finished product. Inventory contributes to COGS (cost of goods sold) and is valued using either the First In First Out (FIFO) or Last In Last Out method.
Assets – Accounts Receivable
The amounts due from customers in respect of sales made to them on credit net of expected returns.
Assets – Property, Plant and Equipment
Tangible (physical substance) long term assets expected to be used by the business for more than one year. They typically incur high costs to the business but produce benefits over several years. Subsequently their cost is allocated to the income statement over time using a process called depreciation.
Liabilities – Accounts Payable
Represents the amount due to suppliers for goods and services that have been delivered.
Liabilities – Income Taxes Payable
The taxes amount expensed in the prior period modified for adjustment to prior period’s estimates.
Liabilities – Debt
This line item will represent a major source of funding for the most businesses. It is a contractual liability and involves a commitment to repay the amount borrowed (principal) as well as all interest payments. The amounts must always be paid on the due date regardless of circumstances.
Represents the ownership stake in the business. Provides a source of funding but unlike liabilities, no repayment obligation exists. Equity is further divided into shareholders’ equity and retained earnings.