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FAQ

A balance sheet is a snapshot of a business financial condition at a specific moment in time, usually at the close of an accounting period. A balance sheet comprises assets, liabilities, and owners’ or stockholders’ equity. Assets and liabilities are divided into short- and long-term obligations including cash accounts such as checking, money market, or government securities. At any given time, assets must equal liabilities plus owners’ equity. An asset is anything the business owns that has monetary value. Liabilities are the claims of creditors against the assets of the business.

Hint: Increase assets with a debit and decrease them with a credit. Increase liabilities with a credit and decrease them with a debit.

The balance sheet must balance—that's why it's called a balance sheet. In other words, the assets must equal the claims on assets. The concept of balancing relies on the accounting equation:

Assets = Liabilities + Owner’s Equity (Capital)

The accounting equation is an essential notion in accounting. The equation derives from assets and claims on assets:

Assets
Claims on Assets
What a company owns

Liabilites:

What a company owes

Owner's Equity:

Claims of owners against the business

 

What a Balance Sheet is Used For

A balance sheet helps a small business owner quickly get a handle on the financial strength and capabilities of the business. Is the business in a position to expand? Can the business easily handle the normal financial ebbs and flows of revenues and expenses? Or should the business take immediate steps to bolster cash reserves?

Balance sheets can identify and analyze trends, particularly in the area of receivables and payables. Is the receivables cycle lengthening? Can receivables be collected more aggressively? Are some debts uncollectable? Has the business been slowing down payables to forestall an inevitable cash shortage?

Balance sheets, along with income statements, are the most basic elements in providing financial reporting to potential lenders such as banks, investors, and vendors who are considering how much credit to grant the firm.


Identifying Assets

Simply stated, assets are those things of value that your company owns. The cash in your bank account is an asset. So is the company car you drive. Assets are the objects, rights and claims owned by and having value for the firm.

Assets are subdivided into current and long-term assets to reflect the ease of liquidating each asset. Cash, for obvious reasons, is considered the most liquid of all assets. Long-term assets, such as real estate or machinery, are less likely to sell overnight or have the capability of being quickly converted into a current asset such as cash.

Since your company has a right to the future collection of money, accounts receivable are an asset-probably a major asset, at that. The machinery on your production floor is also an asset. If your firm owns real estate or other tangible property, those are considered assets as well. If you were a bank, the loans you make would be considered assets since they represent a right of future collection.

There may also be intangible assets owned by your company. Patents, the exclusive right to use a trademark, and goodwill from the acquisition of another company are such intangible assets. Their value can be somewhat hazy.

Generally, the value of intangible assets is whatever both parties agree to when the assets are created. In the case of a patent, the value is often linked to its development costs. Goodwill is often the difference between the purchase price of a company and the value of the assets acquired (net of accumulated depreciation).


Some basic assets and claims on assets:

Assets Claims on Assets
Assets          =        Liabilities         +         Owner's Equity
Cash Accounts Payable Preferred Stock
Inventories Wages Payable Common Stock
Building Taxes Payable Capital Surplus
Land Notes Payable Retained Earnings
Equipment Bonds Payable  
Accounts Recievable Intermediate Term Debt  
Marketable Securities    

 

Identifying Liabilities

Think of liabilities as the opposite of assets. These are the obligations of one company to another. Accounts payable are liabilities, since they represent your company's future duty to pay a vendor. So is the loan you took from your bank. If you were a bank, your customer's deposits would be a liability, since they represent future claims against the bank.

We segregate liabilities into short-term and long-term categories on the balance sheet. This division is nothing more than separating those liabilities scheduled for payment within the next accounting period (usually the next twelve months) from those not to be paid until later. We often separate debt like this. It gives readers a clearer picture of how much the company owes and when.

 

Owners' Equity

After the liability section in both the chart of accounts and the balance sheet comes owners' equity. This is the difference between assets and liabilities. Hopefully, its positive-assets exceed liabilities and we have a positive owners' equity. In this section we'll put in things like Partners' capital accounts, Stock, and Retained earnings.
Hint: Owners' equity is increased and decreased just like a liability: Debits decrease. Credits increase
By the way, retained earnings are the accumulated profits from prior years. At the end of one accounting year, all the income and expense accounts are netted against one another, and a single number (profit or loss for the year) is moved into the retained earnings account. This is what belongs to the company's owners-that's why it's in the owners' equity section. The income and expense accounts go to zero. That's how we're able to begin the new year with a clean slate against which to track income and expense.

The balance sheet, on the other hand, does not get zeroed out at year-end. The balance in each asset, liability, and owners' equity account rolls into the next year. So the ending balance of one year becomes the beginning balance of the next.

Think of the balance sheet as today's snapshot of the assets and liabilities the company has acquired since the first day of business. The income statement, in contrast, is a summation of the income and expenses from the first day of this accounting period (probably from the beginning of this fiscal year).

 

Income and Expenses

Further down in the chart of accounts (usually after the owners' equity section) come the income and expense accounts. Most companies want to keep track of just where they get income and where it goes, and these accounts tell you.

Hint: For income accounts, use credits to increase them and debits to decrease them. For expense accounts, use debits to increase them and credits to decrease them.

 

Income Accounts

If you have several lines of business, you'll probably want to establish an income account for each. In that way, you can identify exactly where your income is coming from. Adding them together yields total revenue.

Typical income accounts would be:

  • Sales revenue from product A
  • Sales revenue from product B (and so on for each product you want to track)
  • Interest income
  • Income from sale of assets
  • Consulting income

Most companies have only a few income accounts. That's really the way you want it. Too many accounts are a burden for the accounting department and probably don't tell management what it wants to know. Nevertheless, if there's a source of income you want to track, create an account for it in the chart of accounts and use it.

 

Expense Accounts

Most companies have a separate account for each type of expense they incur. Your company probably incurs pretty much the same expenses month after month, so once they are established, the expense accounts won't vary much from month to month. Typical expense accounts include

  • Salaries and wages
  • Telephone
  • Electric utilities
  • Repairs
  • Maintenance
  • Depreciation
  • Amortization
  • Interest
  • Rent


Balance Sheet Quick Reference

Assets are subdivided into current and long-term assets to reflect the ease of liquidating each asset. Cash, for obvious reasons, is considered the most liquid of all assets. Long-term assets, such as real estate or machinery, are less likely to sell overnight or have the capability of being quickly converted into a current asset such as cash.

  1. Current Assets are any assets that can be easily converted into cash within one calendar year. There are five main kinds of current assets: Cash & Equivalents, Short and Long-Term Investments, Accounts Receivable, Inventories and Prepaid Expenses that are due within one year’s time. (Note: These are the main assets, your accounting system may contain other assets.)
    • Cash is money available immediately, such as in checking accounts, is the most liquid of all short-term assets.
    • Accounts Receivables is money owed to the business for purchases made by customers, suppliers, and other vendors.
    • Notes Receivables that are due within one year are current assets. Notes that cannot be collected on within one year should be considered long-term assets.
  2. Fixed (Long-term) Assets include land, buildings, machinery, and vehicles that are used in connection with the business.
    · Land is considered a fixed asset but, unlike other fixed assets, is not depreciated, because land is considered an asset that never wears out.
    • Buildings are categorized as fixed assets and are depreciated over time.
    • Office equipment includes equipment such as copiers, fax machines, printers and computers used in your business are fixed assets and are depreciated over time.
    • Machinery used in your plant to produce your product are fixed assets and are depreciated over time. Examples of machinery might include lathes, conveyor belts, or a printing press.
    • Vehicles include any vehicles used in your business are fixed assets and are depreciated over time.
    • Total fixed assets are the total dollar value of all fixed assets in your business, less any accumulated depreciation.
  3. Total Assets represents the total dollar value of both the short-term and long-term assets of your business.

Liabilities and Owners’ Equity includes all debts and obligations owed by the business to outside creditors, vendors, or banks that are payable within one year, plus the owners’ equity. Often, this side of the balance sheet is simply referred to as “Liabilities.”

  1. Current Liabilities is the sum total of all current liabilities owed to creditors that must be paid within a one-year time frame. There are five main categories of current liabilities: Accounts Payable, Accrued Expenses, Income Tax Payable, Short-Term Notes Payable and Portion of Long-Term Debt Payable. (Note: These are the main liabilities, your accounting system may contain other liabilities.)
    • Accounts Payable is comprised of all short-term obligations owed by your business to creditors, suppliers, and other vendors. Accounts payable can include supplies and materials acquired on credit.
    • Notes Payable represents money owed on a short-term collection cycle of one year or less. It may include bank notes, mortgage obligations, or vehicle payments.
    • Accrued Payroll and Withholding includes any earned wages or withholdings that are owed to or for employees but have not yet been paid.
  2. Fixed (Long-term) Liabilities are any debts or obligations owed by the business that are due more than one year out from the current date.
    • Mortgage note payable is the balance of a mortgage that extends out beyond the current year. For example, you may have paid off three years of a fifteen-year mortgage note, of which the remaining eleven years, not counting the current year, are considered long-term.
  3. Owners’ equity is referred to as stockholders’ equity. Owners’ equity is made up of the initial investment in the business as well as any retained earnings that are reinvested in the business.
  4. Common stock is stock issued as part of the initial or later-stage investment in the business.
  5. Retained earnings are earnings reinvested in the business after the deduction of any distributions to shareholders, such as dividend payments.
  6. Total Liabilities and Owners’ Equity comprises all debts and monies that are owed to outside creditors, vendors, or banks and the remaining monies that are owed to shareholders, including retained earnings reinvested in the business.

    Example:

Assets
Claims on Assets
Current Assets:

Cash

$123,000  

Marketable Securities

$200,000  

Accounts Recievable

$345,000  

Inventories

$100,000  
Total Current Assets  
$768,000
     
Long-Term Assets   

Building (Gross)

$350,000  

-Accumulated Depreciation

$ -50,000
 
 

Net Building


$300,000
 

Land

$325,000  
Total Long-Term Assets 
$625,000
     
Total Assets  
$1,393,000
     
  Current Liabilities

Accounts Payable

$100,000  

Notes Payable

$150,000  
Total Current Liabilites
$250,000
 
     

Long-Term Note

$300,000  
Total Liabilites  
$550,000
Owner's Equity   $843,000
     
Total Claims  
$1,393,000