What is a Balance Sheet?
A balance sheet presents a list of 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. It presents a snapshot of a company’s financial position, unlike the income statement which is a record over a period of time.
The main objective of a balance sheet is to outline all the resources (assets) available to a business and how they are funded (liabilities). The liabilities and equity items provide the funds which are invested in assets. Many professionals refer to the balance sheet as a sources and uses statement.
Key Learning Points
- A balance sheet provides a snapshot of a company’s financial position and lists all its assets, liabilities and equity items
- It is based on the accounting equation where: Assets = Liabilities + Equity
- It is one of the key financial statements that companies are required to produce in their annual reports (10-K)
- The balance sheet is a great tool for an analyst to look at the financial position of a business. The most common methods are the use of financial ratios to reflect on the performance, liquidity, solvency and all-round efficiency of a company
- The statement contains many items and specifically lists assets in order of their liquidity i.e how easily they can be converted to cash with little to no loss of value
Balance Sheet Example
The Coca-Cola Company – Balance Sheet
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.
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 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. It provides a source of funding but unlike liabilities, no repayment obligation exists. Equity is further divided into shareholders’ equity and retained earnings. It is the amount of money available to shareholders after all the company’s assets are liquidated and debts are paid off in the event of a liquidation.