Although the balance sheet is a very basic financial statement, it provides an essential glimpse of the company’s well-being. It offers a quick picture of the company’s financial condition at a specific point in time. The company’s condition is determined by comparing the assets versus the liabilities and stockholders’ equity. It is called a balance sheet because the two sides must balance each other out.
Three Categories of the Balance Sheet
- All assets owned by the business
- All liabilities incurred to finance these assets
- All contributed capital and retained earnings, any financing provided by stockholders and earnings retained in the business entity.
Assets are economic resources possessed by a company that can be converted to cash. The balance sheet records the economic value of the assets held by the company. They may be tangible like an office building or intangible like copyrights and computer software. Tangible assets are divided further into two other categories: current assets and long-term assets.
Current assets account for resources that will be sold with the next year. They include very liquid assets like cash, assets for sale like inventory and productive assets like equipment. These are listed under current assets on the balance sheet with the most liquid assets listed first.
Long-term assets are not intended for resale and are held for longer than one year. In this section, depreciation is taken into account. The accountant chooses a depreciation method and applies it to calculate the annual depreciation charge for each which is deducted from the asset’s value.
Liabilities involve legal debts or obligations to lenders, suppliers, and employees. To remove the debt, a business must transfer assets (money or goods) or provide services. Like assets, liabilities are sub-divided into two categories on the balance sheet: current liabilities and long-term liabilities.
Current liabilities are obligations to be settled within the next year. They include accounts payable, wages payable, advertising payable, for example.
Long-term liabilities are obligations to be settled in the future, beyond a year. Often, these involve periodic payments of a principal with interest. They include mortgage loans, promissory notes and deferred taxes.