A balance sheet is one of the key financial statements that provides a snapshot of a company’s financial health at a specific point in time. It outlines the company’s assets, liabilities, and shareholders’ equity to give readers an understanding of what the company owns and owes as well as the amount invested by shareholders.
What are the key elements on a balance sheet?
There are three main elements that make up a balance sheet:
- Assets – These are resources owned by the company that hold future economic value. Assets can be tangible or intangible.
- Liabilities – These are debts or obligations owed by the company. Liabilities represent future sacrifices of economic benefits that the company is required to make.
- Shareholders’ equity – This represents the residual share of assets left over after deducting all liabilities. It’s the amount invested by shareholders plus retained earnings.
Each of these elements provides important insights into the company’s financial standing:
- The asset section outlines what the company owns that can be used to generate future revenues or cash flows.
- The liabilities section outlines what the company owes to outside parties such as banks, suppliers, bondholders etc.
- Shareholders’ equity quantifies the net assets attributable to shareholders.
These core balance sheet elements offer a high-level overview of the company’s resources, obligations, and capital structure.
Assets on the balance sheet
Assets represent economic resources controlled by the company as a result of past transactions or events. Assets have future benefits that are expected to flow to the company. There are two main types of assets:
- Current assets – These are assets that can be converted into cash within one year. Current assets include cash, accounts receivable, inventory, and short-term investments.
- Non-current assets – These are assets expected to provide economic value for longer than one year. Examples include long-term investments, fixed assets like property, plant and equipment, and intangible assets like goodwill and patents.
Common asset accounts found on the balance sheet include:
- Cash and cash equivalents
- Marketable securities
- Accounts receivable
- Inventory
- Prepaid expenses
- Property, plant and equipment
- Investments
- Intangible assets
Liabilities on the balance sheet
Liabilities represent financial obligations or debts owed by the company. Similar to assets, liabilities are classified as either current or long-term:
- Current liabilities – These are financial obligations due within one year. Common current liabilities include accounts payable, short-term debt, accrued expenses, and deferred revenue.
- Long-term liabilities – These are financial obligations that are due in over one year. Typical long-term liabilities are long-term debt, bonds payable, and deferred tax liabilities.
Some of the most common liability accounts on the balance sheet are:
- Accounts payable
- Notes payable
- Accrued expenses
- Unearned revenue
- Current portion of long-term debt
- Long-term debt
- Deferred tax liabilities
Shareholders’ equity on the balance sheet
Shareholders’ equity represents the residual interest in the company’s assets after deducting all liabilities. It reflects the net assets attributable to common shareholders and preferred shareholders based on the amount they invested plus any earnings the company retains.
The key accounts within shareholders’ equity include:
- Common stock – This reflects the amount received by the company when it issued shares to investors.
- Preferred stock – Some companies issue preferred stock which also represents equity financing received.
- Additional paid-in capital – This account tracks additional capital contributions by shareholders above the par value of the shares issued.
- Retained earnings – This is the cumulative net income or profit the company has retained or reinvested over its life rather than distributing it to shareholders.
- Treasury stock – This is the contra account that tracks any repurchase of outstanding shares by the company.
By subtracting total liabilities from total assets, you arrive at total shareholders’ equity which connects the balance sheet in a fundamental accounting equation:
Assets = Liabilities + Shareholders’ Equity
Current Assets
Current assets are balance sheet accounts that represent cash, assets that are expected to be converted to cash within one year, or expenditures that will become assets within one year. Here are some of the most common current asset accounts:
- Cash and cash equivalents – This includes cash on hand, bank deposits, and highly liquid short-term investments like commercial paper.
- Short-term investments – Investments that are expected to be converted to cash within a year, such as marketable equity securities.
- Accounts receivable – Amounts owed by customers for sales on credit. They are expected to be collected within a year.
- Notes receivable – Similar to accounts receivable but formalized using a promissory note.
- Inventory – Raw materials, work in process goods, and unsold finished goods. Expected to be sold within a year.
- Prepaid expenses – Operating expenses like insurance that have been paid in advance and will become expenses within a year.
Current assets are often presented in order of liquidity on the balance sheet, from most liquid to least liquid.
Long-term Assets
Long-term assets are balance sheet accounts representing assets expected to provide value for longer than one year. Common long-term asset accounts include:
- Long-term investments – Investments not expected to be converted to cash within a year, like bonds held to maturity or equity investments.
- Fixed assets – Tangible property like land, buildings, equipment, furniture used in operations. Also called property, plant and equipment (PP&E).
- Intangible assets – Non-physical assets like goodwill, trademarks, patents, copyrights.
- Right of use assets – Assets representing the right to use leased property, under new lease accounting standards.
Long-term assets are presented in order of liquidity on the balance sheet after current assets. Their carrying value is impacted by depreciation and amortization over time.
Current Liabilities
Current liabilities represent financial obligations that are due within one year. The most common current liabilities include:
- Accounts payable – Amounts owed to vendors and suppliers for goods or services purchased on credit.
- Accrued liabilities – Expenses that have been incurred but not yet paid like wages, interest, taxes.
- Deferred revenue – Revenue received in advance before goods or services have been delivered.
- Notes payable – Short-term promissory notes that are due within one year.
- Current portion of long-term debt – Portion of long-term debt due within 12 months.
- Dividends payable – Dividends declared by the company but not yet paid out to shareholders.
Current liabilities are generally presented in order of maturity on the balance sheet, from shortest to longest maturity.
Long-term Liabilities
Long-term liabilities represent financial obligations not due for longer than one year. Typical long-term liability accounts include:
- Long-term debt – Debt like bonds, notes payable, and mortgages that are due in over one year.
- Deferred tax liability – Future tax liabilities arising from temporary differences between accounting and taxable income.
- Pension liability – Projected benefit obligation to employees under a company pension plan.
- Lease liability – Liabilities under long-term lease agreements now recorded on the balance sheet.
Long-term liabilities are presented after current liabilities on the balance sheet based on their due dates. The portion of long-term debt due within one year would be recorded as a current liability.
Paid-in Capital
Paid-in capital represents equity investment into the company by shareholders through purchase of capital stock. Common accounts under paid-in capital include:
- Common stock – Par value or stated value of shares issued to common shareholders.
- Preferred stock – Par value of shares issued to preferred shareholders.
- Additional paid-in capital – Amount paid by investors above the par value for shares issued.
- Treasury stock – Contra account reflecting repurchase of outstanding shares.
Paid-in capital accounts reflect non-cash equity investment made by shareholders when purchasing newly issued shares from the company.
Retained Earnings
Retained earnings refer to cumulative net income or profits retained in the business after dividends are paid out to shareholders. Retained earnings are increased by:
- Net income or net profit
- Prior period adjustments
Retained earnings are decreased by:
- Dividends
- Prior period adjustments
Retained earnings reflect reinvestment of earnings and are not closed out at year-end like income statement accounts. It is an ongoing balance sheet account that shows cumulative earnings retention.
Accumulated Other Comprehensive Income
Accumulated other comprehensive income (AOCI) is a component of shareholders’ equity used to record unrealized gains and losses outside of net income. Typical items recorded in AOCI include:
- Unrealized gains/losses on available for sale securities
- Foreign currency translation adjustments
- Unrealized gains/losses on cash flow hedges
- Pension liability adjustments
AOCI provides a temporary holding place on the balance sheet for unrealized activity until it is reclassified to the income statement upon sale or settlement. It prevents distortion of net income.
Non-Controlling Interest
Non-controlling interest, also called minority interest, represents the portion of a subsidiary corporation’s equity not attributable directly or indirectly to the parent corporation. It appears in the consolidated balance sheet to account for third-party equity interests in consolidated subsidiaries.
For example, if a parent company owns 80% of a subsidiary, the non-controlling 20% interest held by other shareholders would appear as a non-controlling interest component of consolidated equity.
Conclusion
The balance sheet provides a snapshot of a company’s financial resources and obligations at a point in time. The key sections are assets, liabilities, and shareholders’ equity. Assets represent what the company owns, liabilities represent what it owes, and shareholders’ equity represents the residual claim to assets after settling liabilities.
Current assets like cash, accounts receivable, and inventory provide near-term value. Long-term assets like PP&E, intangibles, and investments provide longer-term value. Current liabilities like accounts payable and accrued liabilities are due in the near-term. Long-term liabilities like debt, pensions, and leases are due in over one year.
Shareholders’ equity accounts like common stock, APIC, retained earnings, AOCI, and non-controlling interests represent the net assets owned by various classes of shareholders after accounting for all asset and liability claims. Analyzing these key accounts provides insights into the company’s financial health and capital structure.
