14.4 The Balance Sheet

The balance sheet is a crucial financial statement that shows a company's assets, liabilities, and equity at a specific point in time. It provides a snapshot of a business's financial health, revealing what it owns and owes.

Understanding the balance sheet is essential for assessing a company's financial position. It helps investors, creditors, and managers make informed decisions by analyzing the firm's liquidity, solvency, and overall financial structure.

The Balance Sheet

Purpose and Components

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• Balance sheet provides snapshot of company's financial position at specific point in time, showing what it owns (assets) and owes (liabilities and owners' equity)
• Assets are resources owned by company with economic value, including current assets (cash, accounts receivable, inventory), fixed assets (land, buildings, equipment), and intangible assets (patents, trademarks, goodwill)
• Liabilities are debts and obligations owed by company, consisting of current liabilities due within one year (accounts payable, short-term loans) and long-term liabilities due beyond one year (bonds payable, long-term loans)
• Owners' equity is residual interest in assets after deducting liabilities, including contributed capital invested by owners (common stock, additional paid-in capital) and retained earnings from cumulative net income not distributed to owners
• Fundamental accounting equation: Assets = Liabilities + Owners' Equity, ensuring balance sheet always balances

Asset Types

• Current assets are cash and other assets expected to convert to cash within one year or operating cycle, such as accounts receivable (money owed by customers), inventory (goods held for sale), short-term investments (marketable securities), and prepaid expenses (rent, insurance)
• Fixed assets, also known as property, plant, and equipment, are tangible assets used in business operations with useful life over one year, including land, buildings, machinery, equipment (computers, vehicles), subject to depreciation to allocate cost over useful life
• Intangible assets are non-physical assets providing long-term benefits, such as patents (exclusive rights to inventions), trademarks (distinctive symbols or names), copyrights (original works), goodwill (excess purchase price over fair value), brand recognition, subject to amortization to allocate cost over useful life

Liabilities and Equity

• Current liabilities are obligations expected to be paid within one year or operating cycle, including accounts payable (money owed to suppliers), short-term loans (bank borrowings), accrued expenses (salaries, interest), and unearned revenue (advance payments from customers)
• Long-term liabilities are obligations not due within one year or operating cycle, such as bonds payable (debt securities issued to investors), long-term loans (mortgage, vehicle financing), and deferred tax liabilities (taxes owed in future)
• Owners' equity represents owners' residual interest in company's assets after deducting liabilities, consisting of:
  1. Contributed capital: Amount invested by owners, including common stock (ownership shares) and additional paid-in capital (excess over par value)
  2. Retained earnings: Cumulative net income earned by company not distributed to owners, increasing with profits and decreasing with losses and dividends paid