The balance sheet, which is also known as the statement of financial position, reports a corporation's assets, liabilities, and stockholders' equity account balances as of a point in time. The point in time is often the final instant or moment of the accounting period. Hence it is common for a balance sheet to report a corporation's amounts as of the final instant of December 31.
An interesting point concerning the balance sheet accounts is that the account balances at the final instant of an accounting year will carry forward to become the beginning balances of the subsequent year. (The other four financial statements report amounts for a period of time.)
The format of the balance sheet is similar to the accounting equation:
Assets = Liabilities + Stockholders' Equity
As result of the double-entry system of accounting, the balance sheet and the accounting equation should always be in balance. Here are a few examples:
When a corporation borrows money from its bank, 1) the corporation's assets will increase, and 2) the corporation's liabilities will increase.
When the corporation uses its cash to purchase land for a new warehouse, 1) the asset land increases, and 2) the asset cash decreases.
When a corporation earns $5,000 by providing consulting services, 1) the corporation's assets (such as cash or accounts receivable) will increase, and 2) its stockholders' equity (specifically retained earnings) will increase. Stockholders' equity is increasing because revenues will cause an increase in the amount of net income, and the increase in net income causes an increase in retained earnings.
You can gain additional insights by studying our free Explanation of the Accounting Equation.
Assets are often described as:
- a corporation's resources
- things the corporation owns (as a result of a previous transaction)
- costs that have not yet expired
Some of the accounts used to record a corporation's assets include:
- Marketable Securities
- Accounts Receivable
- Other Receivables
- Prepaid Expenses
- Long-term Investments
- and many others
Normally, the balance sheet will present the asset accounts under one of the following headings:
- Current assets
- Investments (long-term)
- Property, plant and equipment
- Other assets
Liabilities are often described as:
- a corporation's obligations
- amounts the corporation owes
- customer deposits or customer prepayments which a corporation has not yet earned
- Sources (along with stockholders' equity) of the corporation's assets
- Claims against the corporation's assets
Some of the accounts used to record liabilities include:
- Notes Payable
- Accounts Payable
- Wages Payable
- Interest Payable
- Income Taxes Payable
- Other Accrued Expenses Payable
- Customer Deposits
- Loans Payable
- Deferred Income Taxes
- and many others
Liability accounts are usually presented on the balance sheet under one of the following headings:
- Current liabilities
- Noncurrent liabilities or Long-term liabilities
Stockholders' equity (which is also known as shareholders' equity) is defined as a corporation's assets minus its liabilities. Stockholders' equity can be viewed as:
- a residual claim on the corporation's assets (after liabilities)
- a source (along with liabilities) of the corporation's assets
The major components of stockholders' equity include:
- Paid-in capital
- Retained earnings
- Accumulated other comprehensive income
- Treasury stock (a deduction)
Since the reported amounts for a corporation's assets and liabilities reflect US GAAP (including the historical cost principle), the amount of stockholders' equity does not indicate a corporation's current market value. For example, valuable trademarks and brand names that a corporation developed internally are not reported as assets and therefore are not included in the amount of stockholders' equity.
Stockholders' equity will be discussed further under the Statement of Stockholders' Equity.
Format of the Balance Sheet
The following shows the headings and classifications found in a classified balance sheet:
*Every financial statement should inform the reader that the notes are an integral part of the financial statements and should be read for additional important information.
Working Capital and Current Ratio
I believe that bankers will immediately calculate a corporation's working capital when meeting with a loan applicant. Working capital is calculated as follows:
Working capital = current assets minus current liabilities
This means that a corporation with $100,000 of current assets and $100,000 of current liabilities has no working capital. If it has $150,000 of current assets and $100,000 of current liabilities, it has $50,000 of working capital.
Related to working capital, is the current ratio, which is calculated as follows:
Current ratio = current assets divided by current liabilities
Hence a corporation with $100,000 of current assets and $100,000 of current liabilities will have a current ratio of 1:1. If the corporation has $150,000 of current assets and $100,000 of current liabilities, its current ratio is 1.5:1.
The amount of working capital and the current ratio are indicators of a corporation's ability to pay its obligations when they come due. These and other financial ratios can be found in our Explanation of Financial Ratios.
Current assets include cash and the assets that will turn to cash within one year of the balance sheet date (or within the operating cycle, if it is longer than one year). In other words, current assets include:
- Cash equivalents
- Temporary investments
- Accounts receivable (net of the allowance for uncollectible accounts)
- Prepaid expenses
Current liabilities are a corporation's obligations that are due within one year of the balance sheet date (or within the operating cycle, if it is longer than one year) and will require the use of a current asset or will create another current liability. The following are examples of current liabilities:
- Accounts payable
- Wages payable
- Payroll withholdings that need to be remitted
- Bank loans and other borrowings due within a year
- Principal portion of long-term loans (the principal that must be paid within the next 12 months)
- Customer deposits
- Unearned/deferred revenue
- Income taxes payable
For more information and a more complete balance sheet read our Explanation of the Balance Sheet.