With this blog we are going to begin a multi-part series in which we explore, explain, and hopefully enlighten our readers about the often-confusing world of financial statements. We’ll be looking at the three most common statements—the balance sheet, the income statement, and the statement of cash flows—and trying to give you an understanding of how to interpret them and what they are telling you about your business.
Let’s start with the balance sheet, which presents a snapshot of a company’s financial position at a specific moment in time, often on the last day of the month, the quarter or the year. The left side of the balance sheet lists a company’s assets (i.e. the things that it owns). The right side lists the liabilities and equity, which represent the financial obligations that the company has to others. Assets are listed in order of liquidity, or the length of time that it takes to convert them into cash, and liabilities are listed in the order in which they must be paid.
Now let’s take a look at this sample balance sheet from the fictitious ABC Corporation and break down each of the items in a little more detail.
|Assets||Dec. 31, 2010||Liabilities & Equity||Dec. 31, 2010|
|Total current assets||
|Total current liabilities||
|Total common equity||
|Total liabilities and equity||
We’ll begin with the asset side before moving on to liabilities and equity.
Cash – This one is pretty easy. In addition to actual bank notes, cash also includes any money that is immediately available, such as funds in a checking account. Cash is, by definition, the most liquid of all assets.
Accounts receivable – This represents money that is owed to ABC Corp. by its customers.
Inventory – Inventory is the value of the goods that ABC has in its possession but has not yet sold.
Total current assets – Are all assets that can be easily converted into cash within a year. In ABC’s case its total current assets are the sum of its cash, accounts receivable, and inventory.
Fixed Assets – Fixed assets include things such as buildings, machinery, and office equipment which are necessary to run the business but which are not expected to be converted into cash.
Total Assets – Equals the sum of all of the assets of ABC Corp., in this case the figure adds up to $50,000 and is comprised of $35,000 in current, or short-term, assets and $15,000 in fixed, or long-term assets.
On the right side of the balance sheet we see the following items:
Accounts payable – The opposite of accounts receivable, this figure represents the money that ABC owes to suppliers, vendors, and other creditors that is due within a year.
Notes payable – Are loans that must be repaid within a year.
Accrued payroll – Is money that is owed to employees. Because ABC, like most companies, does not pay its employees daily it will accrue this liability to its employees between paydays.
Total current liabilities – All liabilities that must be paid within a year, in ABC’s case accounts payable, notes payable, and accrued payroll.
Long-term debt – Is any financial obligation of ABC’s that is due more than one year from the date the balance sheet was prepared.
Total liabilities – Equals total current liabilities plus long-term debt.
Common stock – Represents the value of the stock that has been issued to investors in ABC Corp.
Retained earnings – Are the earnings of ABC that have been reinvested into the business.
Total common equity – Also known as owners’ equity or stockholders’ equity, this figure is the sum of the value of the common stock plus retained earnings.
Total liabilities and equity – Comprises all of the money that ABC owes to others, plus the value of its common stock and retained earnings, in this case $50,000.
While the precise line items on a balance sheet will differ from company to company, the format that we have laid out here will not vary. And while each company will, of course, have its own unique values for each entry on the balance sheet, one thing that holds true for ABC Corp. holds true for all companies: total assets are equal to total liabilities plus equity. In our next post we’ll explain why this is so and start a more in-depth explanation of how to read and interpret a balance sheet.
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