What is a Balance Sheet?

Published by Thomas Herold in Accounting, Corporate Finance, Investments

'Balance Sheet' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Balance Sheet refers to a corporate financial statement. The purpose of it is to thoroughly summarize the liabilities, assets, and shareholdersequity in the firm at a fixed moment in time. The statement provides a revealing glimpse into the things the corporation owns and the money it owes, along with the total amount which shareholders have invested in the going concern. Where these financial statements are concerned, the formula for assets is liabilities plus shareholders’ equity.

Balance sheets ultimately derive their names from the equation which pits the assets on one side while the shareholders’ equity and liabilities remain on the opposite site. They have to balance out, which provides the concept behind the name. It makes perfect sense that corporations have only two choices when paying for their assets. They might either borrow the money through assuming liabilities or obtain it off of investors, which happens when they issue shareholder equity.

Consider an example to better understand what is involved with this concept. If a corporation obtains a $40,000 bank loan to be repaid in five years, then its assets (cash account section) will rise by the $40,000. At the same time, the total liabilities (long term debt section) will also rise by the $40,000 amount. This restores balance to the equation. Should the firm then receive $80,000 from investors, the assets will also increase by that same amount. On the other side of the equation, the shareholder equity rises by the same $80,000. When the company earns revenues which are greater than the liabilities, these go into the so called shareholder equity account. It is that category that stands for all net assets the owners of the corporation hold. The offsetting revenues balance out on the assets side in the form of inventory, investments, or cash categories.

The three main categories of the balance sheet equation— assets, liabilities, and shareholder equity each break down further into a few of their own sub accounts. These sub accounts actually reveal the particulars of the corporate finances. Every industry will have its own range of sub accounts. Many of the sub account terms will mean different things from one type of business to another. In general, there are always several sub account categories that different industries have in common.

As an example, under the assets category, such sub accounts are broken out from top down to bottom according to which is most liquid. This simply means the ease of selling them for cash. The divisions for all sub accounts will be by current assets and long term assets. The current ones may be changed to cash in under a year. Longer term ones obviously may not be converted so quickly. Current assets generally list top to bottom according to the following precedence: cash or cash equivalents, marketable securities, accounts receivable, inventory, and prepaid expenses. Longer term assets have the following general top down order: long term investments, fixed assets, and intangible assets such as goodwill, trademarks, and intellectual property.

Under the liabilities category will be the total amount firms owe to other entities. These include building rent, salaries, utilities, supplier invoices, and interest on loans or bonds. The current liabilities will be due in under a year, while the longer term ones are due after a year. Some sub accounts for current liabilities include: currently due part of longer term debt, interest payable, bank debts, wages payable, rents/utilities/taxes, dividend payments, and customer prepayments. Under longer term liabilities there are pension fund liabilities, long term debts, and deferred tax liabilities. There can also be off-balance sheet liabilities, like operating leases.

Shareholders’ equity includes money from the owners of the business, the stake holding shareholders. This includes the net assets like treasury stock, retained earnings, preferred stock, and additionally paid in capital.

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The term 'Balance Sheet' is included in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.