What Is a Balance Sheet?

What Is a Balance Sheet?

Let me explain what a balance sheet really is. It's a financial statement that lists a company's assets, liabilities, and shareholders' equity for a specific operating period. You can use it as the foundation for calculating rates of return if you're an investor or for evaluating the company's capital structure.

In essence, the balance sheet gives you a clear snapshot of what the company owns and owes, plus the amount shareholders have invested. Combine it with other financial statements like the income statement or cash flows to perform fundamental analysis or compute financial ratios.

Key Takeaways

Remember, the balance sheet is one of the three core financial statements for evaluating any business. It offers a snapshot of the company's finances—what it owns and owes—for a past period. It always follows the formula where assets equal liabilities plus shareholders' equity. Analysts rely on it to calculate essential financial ratios.

How Balance Sheets Work

A balance sheet gives you a point-in-time view of a company's finances, but it doesn't show trends on its own. That's why you should compare it with previous periods and other statements to get the full picture.

You can derive ratios like debt-to-equity or acid-test from it to gauge financial well-being. The income statement and cash flows add context, and any notes in earnings reports can refer back to it.

The core of it is the accounting equation: Assets = Liabilities + Shareholders’ Equity. This makes sense because a company funds its assets either by borrowing (liabilities) or from investors (equity). For example, if a company borrows $4,000, both assets and liabilities increase by that amount. If it takes $8,000 from investors, assets and equity rise accordingly, balancing out as cash, investments, or other assets.

Special Considerations

Always compare balance sheets with those of other businesses in the same industry, as financing approaches differ. You'll find details on assets, liabilities, and equity here, and they must balance—if not, check for errors like misplaced data or miscalculations.

Categories break down into smaller accounts, varying by industry. Some companies use a common-size balance sheet with percentages for quick comparisons.

Components of a Balance Sheet

Let's break down the main components. Starting with assets, they're listed by liquidity—how easily they convert to cash. Current assets, convertible within a year, include cash equivalents like Treasury bills, marketable securities, accounts receivable (with allowances for doubtful ones), inventory at lower of cost or market, and prepaid expenses like insurance.

Long-Term Assets

Long-term assets cover securities not liquid within a year, fixed assets like land and machinery, and intangibles like intellectual property or goodwill, usually only listed if acquired.

Liabilities

Liabilities are what the company owes outsiders, from bills to interest. Current ones, due within a year, include portions of long-term debt, interest payable, wages payable, customer prepayments, dividends payable, earned/unearned premiums, and accounts payable. Long-term liabilities include bonds, pension funds, and deferred taxes. Some are off-balance-sheet and don't appear.

Shareholder Equity

This is the owners' stake, or net assets after subtracting liabilities. It includes retained earnings for reinvestment or debt payoff, with leftovers as dividends; treasury stock for repurchase; preferred stock with par value; and additional paid-in capital beyond par. Note that par value is often minimal, like $0.01, and equity isn't tied directly to market cap.

Importance of a Balance Sheet

No matter the company size, a balance sheet helps assess risk by showing assets and debt. You can see if borrowing is excessive, assets are liquid enough, or cash meets demands. It's crucial for securing loans or equity funding, as lenders and investors check creditworthiness.

Managers use ratios from it to measure liquidity, profitability, solvency, and turnover. Over time or versus competitors, it reveals improvement paths. For employees, especially in public companies, it shows job security and financial health.

Limitations of a Balance Sheet

It's valuable, but drawbacks exist. Many ratios need data from income statements and cash flows for a full view. It's limited to one day, so without comparisons, it's hard to judge performance—like knowing cash on hand without context.

Accounting methods for depreciation or inventories can alter figures, allowing some manipulation—check footnotes for red flags. Professional judgments, like assessing receivables for impairment, involve estimates that impact the report.

Example of a Balance Sheet

Take Apple's comparative balance sheet from September 2020 versus the prior year. Total assets were $323.8 billion, split into current and non-current, with cash decreasing but non-current increasing. Liabilities and equity sections show increases in liabilities, decreases in equity, balancing to total assets.

Why Is a Balance Sheet Important?

Executives, investors, analysts, and regulators use it to grasp current financial health, alongside income and cash flow statements. It answers if net worth is positive, cash covers obligations, or debt is high relative to peers.

What Is Included in the Balance Sheet?

It covers assets like cash, receivables, or property, and liabilities like payables, wages, or loans—short-term or long-term.

Who Prepares the Balance Sheet?

For small businesses, the owner or bookkeeper might handle it. Mid-sized firms prepare internally then audit externally. Public companies need GAAP-compliant audits and SEC filings.

What Are the Uses of a Balance Sheet?

Outsiders use it to gauge health via ratios on risk, liquidity, and solvency. Internally, it aids risk measurement, cash evaluation, and capital decisions—though less helpful than income statements.

What Is the Balance Sheet Formula?

It's Assets = Liabilities + Shareholders' Equity, summing all asset types against liabilities and equity from income, earnings, contributions, and stock.

The Bottom Line

The balance sheet details a business's assets, liabilities, and equity, letting you analyze its position at a date. Use it for fundamental analysis by comparing periods.