Post by admin1 on Jan 9, 2006 19:49:25 GMT -5
A balance sheet, also known as a "statement of financial position", reveals a company's assets, liabilities and owners' equity (net worth). It, together with the income statement, makes up the cornerstone of any company's financial statements. If you are a shareholder of a company, it's important that you understand how the balance sheet is structured and how to read it.
How it Works
The balance sheet is divided into two parts that, based on the following equation, must equal each other: assets = liabilities + owners' equity. This means that assets, or the means of production, are balanced by a company's financial obligations and the amount of money available to finance its operations.
Assets are what a company uses for its production process, while liabilities are obligations to be paid to outside parties. Owners' equity, referred to as shareholders' equity in a publicly traded company, is the amount of money initially invested into the company plus any retained earnings, and represents the source of the business's funding.
A balance sheet represents a specific period of time (usually one day) and is most commonly calculated on the last day of a company's fiscal year, Dec 31.
Types of Assets
Current Assets
Three types of assets are included in the balance sheet: current assets, fixed assets and intangible assets. Current assets have a life span of one year or less, meaning they can easily be converted into cash. Such assets are cash and cash equivalents, accounts receivable and inventory. All are short-term, highly liquid assets that can easily be converted into cash and used as currency.
Cash, the most fundamental of current assets, also includes non-restricted bank accounts and checks. Cash equivalents are stocks and other money market instruments such as U.S. Treasuries that can be quickly changed into money.
Accounts receivable are the short-term obligations owed to the company from clients. Accounts receivable for a company selling a good could expect to receive monthly installments from its clients, while accounts receivable for a company offering a service could be in the form of monthly subscription fees.
Finally, inventory represents the amount of materials currently available for production. If the firm is manufacturing a product, the inventory is divided into three different stages: raw materials, work-in-progress (WIP) and finished goods. Inventory for businesses that sell retail will consist of products purchased from the manufacturer and yet to be sold to the public.
Long-Term Assets
Long-term assets, also known as fixed assets, have a life span of over one year. They can refer to tangible assets such as machinery, computers, buildings and land. Depreciation is calculated and deducted from these types of assets.
Long-term assets can also be intangible assets, such as a website domain, or a patent or copyright. While these assets are not physical in nature, they are often the resources that can make or break a company - the value of a brand name, for instance, should not be underestimated.
Types of Liabilities
On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside clients. Like assets, they can be both current and long-term. Long-term liabilities are debt that has more than a year's maturity.
Current liabilities are typically paid within one year or less, and are therefore paid with current assets. Because current assets pay for current liabilities, the ratio between the two is important: a company should have enough of the former to cover the latter. Current liabilities include such items as dividends payable, accounts payable (what the company owes to suppliers for buying raw materials or retail products on credit), interest payments on long-term debt and taxes payable.
Owners' Equity
Owners' equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings (after taxes) into the company, the retained earnings will be restated from the income statement onto the balance sheet here. The sum of the two figures represents a company's total net worth. In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus owners' equity on the other.
How it Works
The balance sheet is divided into two parts that, based on the following equation, must equal each other: assets = liabilities + owners' equity. This means that assets, or the means of production, are balanced by a company's financial obligations and the amount of money available to finance its operations.
Assets are what a company uses for its production process, while liabilities are obligations to be paid to outside parties. Owners' equity, referred to as shareholders' equity in a publicly traded company, is the amount of money initially invested into the company plus any retained earnings, and represents the source of the business's funding.
A balance sheet represents a specific period of time (usually one day) and is most commonly calculated on the last day of a company's fiscal year, Dec 31.
Types of Assets
Current Assets
Three types of assets are included in the balance sheet: current assets, fixed assets and intangible assets. Current assets have a life span of one year or less, meaning they can easily be converted into cash. Such assets are cash and cash equivalents, accounts receivable and inventory. All are short-term, highly liquid assets that can easily be converted into cash and used as currency.
Cash, the most fundamental of current assets, also includes non-restricted bank accounts and checks. Cash equivalents are stocks and other money market instruments such as U.S. Treasuries that can be quickly changed into money.
Accounts receivable are the short-term obligations owed to the company from clients. Accounts receivable for a company selling a good could expect to receive monthly installments from its clients, while accounts receivable for a company offering a service could be in the form of monthly subscription fees.
Finally, inventory represents the amount of materials currently available for production. If the firm is manufacturing a product, the inventory is divided into three different stages: raw materials, work-in-progress (WIP) and finished goods. Inventory for businesses that sell retail will consist of products purchased from the manufacturer and yet to be sold to the public.
Long-Term Assets
Long-term assets, also known as fixed assets, have a life span of over one year. They can refer to tangible assets such as machinery, computers, buildings and land. Depreciation is calculated and deducted from these types of assets.
Long-term assets can also be intangible assets, such as a website domain, or a patent or copyright. While these assets are not physical in nature, they are often the resources that can make or break a company - the value of a brand name, for instance, should not be underestimated.
Types of Liabilities
On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside clients. Like assets, they can be both current and long-term. Long-term liabilities are debt that has more than a year's maturity.
Current liabilities are typically paid within one year or less, and are therefore paid with current assets. Because current assets pay for current liabilities, the ratio between the two is important: a company should have enough of the former to cover the latter. Current liabilities include such items as dividends payable, accounts payable (what the company owes to suppliers for buying raw materials or retail products on credit), interest payments on long-term debt and taxes payable.
Owners' Equity
Owners' equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings (after taxes) into the company, the retained earnings will be restated from the income statement onto the balance sheet here. The sum of the two figures represents a company's total net worth. In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus owners' equity on the other.