A balance sheet is one of the first financial statements you’ll come across when analyzing companies. A balance sheet provides a snapshot of the financial state of a company at a certain point in time. For instance, this is the balance sheet of a company called, rather imaginatively, Example Company.
Components of a balance sheet
There are three parts to a balance sheet. A balance sheet lists:
1.The firms assets (Assets): These are assets the firm owns. These can be cash, machinery, land or inventory, with their values listed alongside. Example Company, thus, on 31st December 2017, as it says on top of the balance sheet, has $2,100 in cash, and $31,000 worth of inventory. It has accounts receivable of $40,500, meaning that it’s sold goods worth $40,500 on credit, and is expected to receive that money as cash soon.
2. The firm’s liabilities (Liabilities): These are liabilities that the firm owes other people. Example corporate has accounts paybable of $35,000, which means that it owes $35,000 to someone. The other payables are also amounts it owes — the wages payable, for instance, is the wages it owes to its employees (assuming it pays salaries at the end of the month), and interest payable is the interest it’s accrued on its other loans till the date the balance sheet is made.
3. Owner’s equity: This section is the actual value of the company, and is equal to the difference between the assets and liabilities.
Owners equity = Assets – Liabilities
The stocks that people own are a part of owners equity. Stockholders are part owners of the company, and they own the (Assets – Liabilities) of the company. If the company’s assets grow, either because it receives a cash payment, or a fulfils a new order, the value of owner’s equity grows, and the stock price indirectly rises. Whenever the company’s liabilities rise, owners equity falls, and the stock price tends to fall.
The balance sheet always balances
Why is a balance sheet called a balance sheet? It’s called so because it always balances. This means that the equation of Assets = Liabilities + Owners equity always holds. If it doesn’t, the balance sheet hasn’t been constructed correctly.
The balance sheet presents a snapshot of the company at a particular point in time
One last point about balance sheets — a balance sheet represents the financial situation of a company at a particular point in time. So for Example Company, the balance sheet carries the date of 31st December 2017. The numbers are true only for that particular day. If a balance sheet were to be constructed on 1st January 2018, it’s possible that the numbers will look different. Some other financial instruments present the picture of a company over a period of time, such as a quarter, or half a year. We’ll read about them in the coming articles.