The balance sheet: How to read

Key takeaways:

“The balance sheet is a snapshot of what a given company owns and owes at the time of reporting.”

The balance sheet is divided into two main halves: “assets” and “liabilities and shareholders’ equity”.

The first half will tell us what the company owns and the second half will show us what the company owes to creditors and shareholders. The two halves should always offset each other as every dollar in assets has been financed either by shareholders’ equity or by creditors (liabilities).

Assets

So let’s start with the upper half of the balance sheet “assets”.

The assets section includes all the goods and property owned by the company, as well as uncollected amounts, called “receivables”, that are due to the company from others.

Assets = Liabilities + shareholders’ equity

Let’s look at the two parts of the assets section:

  • Current assets (held < 12 months)
  • Non-current assets (held > 12 months)

Current assets

Current assets are either cash or assets that will be converted into cash within the next 12 months from the date of the balance sheet.

Common examples of current assets are:

  • Cash and cash equivalents: Money on hand or in highly liquid securities
  • Accounts receivable: The amounts due from customers but not yet collected. For example, goods shipped by the company but not yet paid by the customer.
  • Inventory: Products in stock yet to be sold. These can be, Raw materials; Unfinished goods; Finished goods.
  • Prepaid expenses: Payments made for which the company has not yet received benefits, but will receive within the next 12 months.
  • Short-term investments: Short-term securities that are easily salable. (these are usually high quality and highly liquid investments)

Current assets ex

Non-current assets (fixed long-term assets)

Assets with a useful life longer than 12 months and that will not be converted into cash within the accounting year.

 

Common examples of non-current assets are:

  • Long-term investments: These are less liquid securities that the company intends to hold longer than 12 months. For example, Stocks or bonds from other companies, treasury bonds, and real estate.
  • Total Property, plant, and equipment: These are assets with a useful life longer than 12 months and are not intended for sale. These assets are used to manufacture, display, transport, … the company’s products. For example, buildings, machinery, leasehold improvements, trucks, …
  • (Less accumulated depreciation):  Depreciation of an asset is the decline in useful value of a fixed asset due to “wear and tear” from use and the passage of time. A company will for accounting purposes amortize the cost of acquiring a fixed or intangible asset over its useful life.For example, A truck that has been bought for $ 100.000 with an estimated useful life of 10 years could be amortized at $ 10.000 a year.
  • Net property, plant, and equipment: Total property, plant, and equipment – Accumulated depreciation.
  • Intangible assets: Assets having no physical existence but nonetheless have substantial value to the company. For example, patents, franchises, trademarks, etc…
  • Deferred charges: Deferred charges are similar to prepaid expenses but will not be included in current assets because their benefits will be realized in periods more than one year from the balance sheet.

non-current assets ex

Liabilities & Shareholders’ equity

Lets now look at the liabilities & shareholders’ equity section of the balance sheet.  This will detail what the company owes to its creditors and shareholders.

Let’s start with the liabilities part.

Liabilities

Liabilities are obligations of the company to its creditors. Liabilities also include amounts received in advance for future services.

Liabilities = Assets – Shareholders’ equity

As with assets, we differentiate two types of liabilities:

  • Current liabilities (due < 12 months)
  • Non-current liabilities (due > 12 months)

Current liabilities

Current liabilities are obligations due and payable within 12 months. The current liabilities correspond to the current assets because the current assets are used to pay off the current liabilities.

Current assets and current liabilities are used in some important metrics such as, “working capital” and “the current ratio”. Other important metrics you find here.

Common examples of current liabilities are:

  • Accounts payable: The amount the company owes to regular business creditors from who it has bought goods or services that not yet have been paid.
  • Short-term loans (notes payable): Money owed to banks, individuals, corporations or other lenders and due within 12 months.
  • Current income taxes payable: Amounts due to the federal state, and local tax authorities within 12 months.
  • Accrued expenses: Items owed but unpaid at the date of the balance sheet. For example, wages to employees, interest on funds borrowed, etc…)
  • Unearned revenue (deferred revenue): Money from the customer received by the company for a service or product that not yet has been provided or delivered. When the product or service eventually is delivered or provided, the unearned revenue liability disappears and becomes revenue on the income statement.
  • Current portion of long-term debt: Represents the portion of any long-term debt that is due within 12 months of the balance sheet date.

current liabilities ex

Non-current liabilities (long-term liabilities)

Non-current liabilities are obligations due and payable after 12 months from the date of the balance sheet.

Common examples of non-current liabilities include:

  • Long term debt: Includes long term loans and other liabilities that will not become due within one year of the balance sheet date.
  • Deferred income tax: These are tax liabilities a company will be required to pay at some future date.
  • Other: All debt due more than one year from the date of the balance sheet, other than specifically reported elsewhere on the balance sheet.

non-current liabilities ex

Shareholders’ equity

Shareholders’ equity is equivalent to a company’s net worth because it represents the total equity interest all shareholders have in the company.

Shareholders’ equity is often referred to as “net assets” because it represents the amount in assets left after all liabilities have been paid.

Shareholders’ equity = Assets – liabilities 

Common examples of Shareholder’s equity are:

  • Preferred stock: Preferred stock is equity ownership that is different from common stock in a number of ways.
  • Common stock: Shares issued at par value are reported under “common stock.” (Par value = the minimum price at which the shares for a company can be issued.)
  • Additional paid-in capital: The amount paid by shareholders in excess of the par value of each share.
  • Retained earnings: Accumulated profits that the company “retains” into the business. These are the earnings that are reinvested into the company.
  • Foreign currency translation adjustments (net of taxes): In some cases, a company with subsidiaries in foreign countries has to translate the financial reports of those foreign subsidiaries to dollar amounts.  The gain or loss resulting from this translation, net of taxes is reported as “foreign currency translation adjustments”.These adjustments are distinct from conversion gains or losses related to completed transactions in foreign currencies.

Knipsel

 

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