Balance sheet

. Meaning of Balance Sheet

The balance sheet provides a summary of the assets and liabilities of a business. It is a snapshot of those assets at a particular moment in time.

The balance sheet always balances because of the use of “double-entry” bookkeeping to record business transactions.

Every transaction in a business always has two equal effects on the assets and liabilities of a business. Some examples are shown below.

1. Content of Balance Sheet

Most of the contents of a business’s balance sheet are classified under one of three categories: assets, liabilities, and owner equity. Some balance sheets, though, also include a “notes” section wherein relevant information that does not fit under any of the above accounting categories is included. Information that might be included in the notes section would include mentions of pending lawsuits that might impact future liabilities or changes in the business’s accounting practices.

ASSETS Assets are items owned by the business, whether fully paid for or not. These items can range from cash—the most liquid of all assets—to inventories, equipment, patents, and deposits held by other businesses. Assets are further categorized into the following classifications: current assets, fixed assets, and miscellaneous or other assets. As David H. Bangs Jr. related in Finance: Mastering Your Small Business, “the list of assets starts with cash and ends with the least liquid fixed assets, those that are the hardest to turn into cash. For instance, if you have an item labeled ‘good will’ on your balance sheet, you’ll have to sell the business itself to turn that particular asset into cash.”

Current assets include cash, government securities, marketable securities, notes receivable, accounts receivable, inventories, prepaid expenses, and any other item that could be converted to cash in the normal course of business within one year. Fixed assets, meanwhile, include real estate, physical plant, leasehold improvements, equipment (from office equipment to heavy operating machinery), vehicles, fixtures, and other assets that can reasonably be assumed to have a life expectancy of several years. It is recognized, however, that most fixed assets—although not land—will lose value over time. This is known as depreciation. When determining a company’s fixed assets, then, a business owner needs to make certain that depreciation is figured into the final value of his or her fixed assets. The net fixed asset value of a company’s holdings is calculated as the net of cost minus accumulated depreciation. Finally, businesses often have assets that are less tangible than securities, inventory, or high-speed printers. These are classified as “other assets” and include such intangible assets as patents, trademarks, and copyrights, notes receivable from officers or employees, and contracts that call for them to serve as exclusive providers of goods or services to a client. Writing in Finance for Non-Financial Managers and Small Business Owners, Lawrence W. Tuller defined intangible assets as “any expenditure that adds value to the company but cannot be touched or held.”

LIABILITIES Liabilities, on the other hand, are the business’s obligations to other entities as a result of past transactions or events. These entities range from employees (who have provided work in exchange for salary) to investors (who have provided loans in exchange for the value of that loan plus interest) to other companies (who have supplied goods or services in exchange for agreed-upon compensation). Liabilities are typically divided into two categories: short-term or current liabilities and long-term liabilities.

Liabilities that qualify for inclusion under the short-term or current designation include all those that are due and payable within one year. These include obligations in the areas of accounts payable, taxes payable, notes payable, accrued expenses (such as wages, salaries, withholding taxes, and FICA taxes) and other expenses that are supposed to be paid off over the next year. Such obligations include the portion of long-term debt that is scheduled to be paid off during the course of the coming year. Long-term liabilities are those debts to lenders, mortgage holders, and other creditors that will take more than one year to pay off.

OWNERS’ EQUITY Once a business has determined its assets and liabilities, it can then determine owners’ equity, the book value of the business’s assets once all liabilities have been deducted. Owners’ equity, which is also sometimes called stockholders’ equity, is in essence the net worth of the company.

1. Classification of Balance Sheet Items

Assets

The assets accounts show how the company has used the money it has obtained from lenders, investors, and company earnings. Technically, according to GAAP, assets are resources with “probable future economic benefits obtained or controlled by an entity resulting from past transactions or events.” This leads to some non-intuitive results. Important resources like intellectual property or longstanding business relationships, though valuable to a business, are generally not reflected on the balance sheet.

Assets are grouped as monetary (cash and accounts receivables), liquid (whether they can easily be converted to cash), tangible or intangible.

Current assets: cash and those items, such as accounts receivable, that are normally expected to be converted into cash within one year.

Non-current assets:

Fixed assets: the company’s more or less permanent physical assets, such as its land, buildings, machinery and equipment

Intangible assets: goodwill, trademarks, copyrights, patents (reader beware!)

Depreciation

these are all terms that refer to allocating the cost of along-lived asset to consecutive accounting periods as expenses until the full cost is fully accounted for.

Intangible Assets

This item has become more important as intellectual property (patents, trademarks, copyriyrights) has become the darlings of the information age. Typically, IP is carried at its acquisition or development cost.

Liabilities

The second portion of the balance sheet consists of the company’s liabilities — usually separated into current liabilities and long-term liabilities. Liabilities can be understood as the opposite of assets — they represent obligations of the business. Not all obligations to make a payment in the future are reflected on the balance sheet. For example, an obligation to pay employees’ rising health care costs may be a significant commitment , it might not be represented on the balance sheet if sufficiently uncertain. Or the prospect of paying clean-up fees for a toxic site owned by the business may not make it to the balance sheet, though it may be described in a note.

Owners’ Equity

The third and final portion of a balance sheet represents the owners’ equity. In a sole proprietorship (a business with one owner), the ownership account is known as “proprietor’s equity”; in a partnership, the ownership account is “partners’ capital.”

Assessment

Define a Balance sheet and state its contents.