The balance sheet, or the statement of financial position, lists the items owned or controlled by a company. It includes debts owed by the firm along with the ownership interest of the firm. The key word in this phrase is balance.
Balance sheets must demonstrate equality. A company’s assets must equal its liabilities plus the stockholders’ equity.
Assets = Liabilities + Stockholders’ Equity
To understand this sheet, let’s dissect its five basic areas:
- Current assets
- Fixed assets
- Current liabilities
- Long-term liabilities
Current refers to one year or less. In the case of current assets, this implies cash or assets that will be turned into cash during this period.
Current assets can include:
- Accounts receivable: This is money due to the company by customers from the sale of a product or the delivery of a service.
- Inventory: This includes items in a warehouse, stocked in a store, and sitting on the shelves available for customer purchase.
Typically, total current assets is equal to cash + accounts receivable + inventory.
In the case of a service company, where there is no inventory per se, current assets equal cash + accounts receivable.
Fixed assets include buildings, machinery, and purchased vehicles used in day-to-day operations. This is the area where your capital equipment affects they way you handle your accounting.
If you deduct the depreciated value of your equipment and property, you’re then left with net fixed assets — the original value minus its depreciated value. This figure will change as the value declines, when new equipment is added, or when old equipment is taken out of service.
Current liabilities refers to debts that will be settled within one year of the preparation date of the balance sheet.
All debts are claimed against a company’s assets. Think of your home — if you own it. The outstanding balance on the mortgage is the liability. The asset is the value of the home.
For most of us, we won’t pay it off in the next year without a very successful year. Most accountants wouldn’t recommend eliminating this personal deduction.
A few sub-categories of current liabilities include:
- Accounts payable includes goods, services, and supplies that you’ve purchased, for use in your business operations and for which you’ve not yet paid. For example, these could be the raw materials you may need for the manufacturing of your product or the supplies you need to run your service company.
- Notes payable, in comparison, are short-term obligations that are payable within the year. This could be with a bank or other financial institution, an economic development board, or some other entity. These are normally scheduled payments, although they can be a single lump-sum payment.
Again, liabilities are logged against company assets, and in this case, these liabilities are long-term, or due beyond a one-year period. Mortgages and other long-term debts typically fall into this category.
Bonds can also fall into this category. The various forms and features of bonds can include debenture bonds, convertible bonds, subordinated debentures, sinking funds, indentures, and interest on debt.
The fifth area on the balance sheet is equity; this can include stockholder’s equity, preferred stock, additional paid-in capital, retained earnings, and treasury stock.
The balance sheet is a snapshot of a business at a particular moment. Just like the photographs you take, what you’ve captured is different both before and after the shot.
The balance sheet is like nature: Change happens. This is good. Just be sure that you have a clearly focused snapshot — fuzzy figures serve no one, especially the small-business owner.
Carol Parenzan Smalley is an educator, innovator, and entrepreneur. She is the creator of and instructor for Creating a Successful Business Plan, an online course offered by colleges and universities around the world.