Few
things are as important and fundamental to discerning the financial
position of a company than the balance sheet. This key snapshot shows
the companys assets, liability, and owners equity. It is crucial that
current and prospective shareholders understand the basics of the
balance sheet and how it works.
As opposed to the cash flow
and income statements, the balance sheet is a snapshot at a given time,
rather than a performance over a period of time. There are two sides of
the balance sheet, which creatively enough, balance each other out.
This key formula is the basis of the balance sheet:
Assets = Liabilities + Equity
The
gist of this equation is that assets, or the things that companies own
in the production process equals its financial obligations and the
amount of money available to finance its operations. Owners equity is
the source of a companys funding and is the amount initially invested
in the company plus retained earnings.
BASIC COMPONENTS
Assets can be broken down into
current assets and long-term assets. The former are more liquid and
have a lifespan of a year or less, while the latter is tougher to
convert into cash. Cash, inventory and accounts receivable are included
in the current asset category. Tangible assets such as factories,
computers, and buildings as well as intangible assets such as patents
are included in long term assets.
On the flipside, liabilities
can also be characterized as current and long-term. Current liabilities
are obligations that need to be paid within a year. Examples are
dividends payable, accounts payable, taxes payable, and interest
expense.
Owners equity is the initial amount of money invested
into a firms business. If a company decides to reinvest its net
earnings (after taxes) into the company, the retained earnings will be
restated from the income statement onto the balance sheet.
ASSESSING NUMBERS
One useful ratio is called the
Current Ratio, which can be calculated using current assets/current
liabilities. This is an excellent tool to determine whether or not a
company can meet its immediate obligations. There is no set rule for
what this number should be, but generally 2 and higher is best.
Debt-to-equity
is another useful indicator that can be found on the balance sheet.
This ratio can be calculated as total liabilities/total shareholders
equity. If a company takes on too much debt as a percentage of equity,
bankruptcy could be on the way.
SAMPLE BALANCE SHEET
| Vandelay Industries Balance Sheet December 31, 200X |
| Assets |
Liabilities and Capital |
| Current Assets |
Current Liabilities |
| Cash |
$12,300 |
|
Account payable |
$8,900 |
|
| Account receivable |
$22,900 |
|
Wages payable |
$11,525 |
|
| Inventory |
$32,090 |
|
Total Current Liabilities |
$20,425 |
| Prepaid Insurance |
$2,500 |
|
Long Term Liabilities |
| Total Current Assets |
$679,790 |
Bank Loan Payable |
$17,500 |
|
| Fixed Assets |
Total Long-Term Liability |
$17,500 |
| Equipment |
$100,200 |
|
Total Long-Term Liability |
$17,500 |
| Less Accum. Deprec |
($78,321) |
|
Capital |
| Total Fixed Assets |
|
$21,879 |
Tom Beta, Capital |
|
$53,744 |
| Total Assets |
$91,669 |
Total Liabilities/Capital |
$91,669 | |
