Balance sheet / B/S /Statement of of Financial Position

The balance sheet, B/S, (sometimes called a statement of financial position) is one of the four primary financial reports that publicly held companies must file every quarter and year. The other three are the Income Statement, Cash Flow Statement (or Statement of Changes in Financial Position), and the Statement of Retained Earnings.

The balance sheet reports what the company owns outright (equities), what the company owes (liabilities), and the resources the company has to work with (assets), at one point in time.

Regarding time, the company could in principle publish a new balance sheet every day, but it is only required to do so at the end of fiscal quarters and years. This contrasts with the Income Statement and Statement of Changes in Financial Position (Cash Flow Statement), which report on financial performance and changes for a specific period of time (the fiscal quarter or year). The balance sheet will be headed with a statement that identifies the time of this financial position "snapshot" that might read, for instance, "...at 31 December 2011."

The balance sheet’s 3 main sections represent the so called accounting equation:

Assets = Liabilities + Owners Equity

The term "balance" means that a company’s assets must equal (balance) the sum of its liabilities and owner’s equities. This balance holds, always, regardless of whether the company's financial position is good, or terrible.

Analysts evaluate the "health" of the company's financial position not by the overall magnitude of the Assets number, or its balancing counterparts, but rather by the relationships between numbers on the balance sheet (see the section on Balance Sheet Contributions to Financial Statement Metrics and Ratios, below.

• Balance Sheet: Simple Example
• Keeping the Balance: Debits and Credits
• Detailed Balance Sheet Example
• Balance Sheet Contributions to Financial Statement Metrics and Ratios

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Balance Sheet: Simple Example and Main Categories

This simple balance sheet example shows the major categories usually reported under assets, liabilities, and equities.

Grande Corporation Figures in 1,000s
Balance Sheet at 31 December 2011

  Assets
   Current Assets ............................. 9,609
   Long Term Investments & Funds .............. 1,460
   Property, Plant & Equipment ................ 9,716
   Intangible Assets........................... 1,222
   Other Assets................................    68
     Total Assets..................................... 22,075

  Liabilities
   Current Liabilities........................  3,464
   Long Term Liabilities...................... 5,474
     Total Liabilities ...............................  8,938

Owners Equity
   Contributed Capital........................  9,439
   Retained Earnings .......................... 3,698
     Total Stockholder's Equity....................... 13,137
       Total Liabilities and Equities ................ 22,075

The entire balance sheet is sometimes presented in horizontal layout, with an Assets Page on the left, and a page for Liabilities and Equities on the Right. Alternatively, it can be presented in vertical format (as above), with the Assets Section above the Liabilities and Equities sections that, together, balance it..

The main categories shown above are defined after the more detailed balance sheet example below.

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Keeping the Balance: Debits and Credits

Many people readily understand the structure and mathematics of the income statement, but have trouble understanding the balance sheet. One reason for this, probably, is that the income statement simply starts with revenues, and then subtracts expense items to reach a bottom line net profit, which is easy to understand, whereas balance sheet mathematics really require at least a simple understanding of double entry bookkeeping.

Both the income statement and the balance sheet start with simple equations. For the income statement, this is:

Income = All Revenues – All expenses and costs

The balance sheet starts with an equally simple equation, the so-called Accounting Equation:

Assets = Liabilities + Owners Equity

Regarding the balance sheet and double entry bookkeeping, it is sometimes said that the "Accounting Equation" above must be extended to include this component:

Debits = Credits

In normal usage, people think of debits to, say, their checking accounts, simply as subtractions, and credits to the checking account simply as additions. Banks in fact use this terminology on statements to account holders. To accountants, the bank's usage is technically correct, but this is only because the bank regards an account holder's account as a liability account for the bank. In double entry bookkeeping, for accounts on the "Liabilities and Equities" side of the balance sheet::

Increasing the value of a liability, equity, or so-called revenue account is a credit.
Decreasing the value of a liability, equity, or revenue account is a debit.

On the other side of the balance sheet—the "Assets" side—the rules for debits and credits are reversed:

Increasing the value of an asset or an expense account is called a debit.
Decreasing the value of an asset or an expense account is called a credit.

In double entry bookkeeping and accounting, every transaction must impact at least two accounts. Whether the impact is called a "debit" or a "credit," depends on the kind of account involved, as described above.

Suppose the company acquires assets valued at $1,000. An asset account (perhaps under Current Assets) increases $1,000—considered a debit transaction because the account is on the asset side of the balance sheet. The balance sheet is now temporarily out of balance, until a second transaction is made, a credit transaction of the same size. This could be either

A corresponding reduction in another account on the Asset side of the sheet, e.g., a credit (i.e. reduction ) to a cash account also under Current assets, or a credit to an Expense account (which will be transferred to the Asset side of the balance sheet)
A corresponding increase in an account on the Liabilities and Equities side of the balance sheet, e.g., an increase (credit) of $1,000 to a long term liabilities account if the purchase funds were borrowed.

In this way, balance sheet assets will always equal liabilities plus equities and debits will always equal credits.

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Detailed Balance Sheet Example

A more detailed version of the balance sheet example from above is presented here. Definition for the major categories and line items appear below the example.

Grande Corporation Figures in 1,000s
Balance Sheet at 31 December 2011

  Assets
   Current Assets
     Cash...................................... 1,369
     Short term investments....................   137
     Accounts receivable............... 1,969
       Less allowance doubtful accts...   137
         Net accounts receivable............... 1,832
     Notes receivable short term...............    20
     Inventories
       Raw materials...................   611
       Work in progress................ 1,692
       Finished goods/merchandise ..... 3,664
       Operating & office supplies.....    19
         Total inventories....................  5,986
     Prepaid exp & insurance, deferred taxes..     37
         Total current assets ........................  9,609
   Long Term Investments & Funds
     Common stock held.........................   493
     Preferred stock held .....................   184
     Bonds held/sinking funds .................   364
     Other long term investments...............   419
         Total long term investments and funds......... 1,460
   Property, Plant & Equipment
     Factory mfr. equipment ........... 5,983
       Less accumulated depreciation .. 2,782
         Net factory mfr equipment. ........... 3,201
     Store/Equipment Selling assets.... 5,456
       Less accumulated depreciation... 1,292
         Net store equipment................... 4,164
     Computer systems.................. 4,721
       Less accumulated depreciation... 2,370
         Net Computer Systems.................  2,351
            Total Property, Plant & Equipment.........  9,716
   Intangible Assets
     Copyrights............................... 1,014
     Trademarks and patents...................   108
     Goodwill.................................   100
       Total intangible assets........................  1,222
   Other Assets.......................................     68
     Total Assets..................................... 22,075

Liabilities
   Current Liabilities
     Accounts payable ........................  1,642
     Notes payable, short term................    912
     Current portion of long term debt .......    130
     Accrued expenses /interest payable ......    146
     Unearned revenues........................    274
     Taxes payable / Other withholdings.......    141
       Total current liabilities......................  3,464
   Long Term Liabilities
     Bank notes payable.......................    912
     Bonds payable & other long term liab.....  4,562
       Total long term liabilities....................  5,474

     Total Liabilities ............................... 8,938

Owners Equity
   Contributed Capital
     Preferred stock................... 3,798
     Common stock...................... 4,184
     Contributed capital excess of par. 1,457
       Total contributed capital............... 9,439
   Retained Earnings .......................... 3,698
     Total Stockholder's Equity....................... 13,137
       Total Liabilities and Equities ................ 22,075

On the Assets side of the balance sheet, the major categories are:

Current Assets: These are assets that, in principle, could be turned into cash in a relatively short time. "Short time" is generally understood to be one year or less. Current assets includes, of course cash on hand, but also short term investments, accounts receivable, inventories, and prepaid expenses.

Long Term Investments and Funds: These are assets that are not so easily turned into cash quickly, which include ownership of stocks and bonds in other companies, as well as other long term (over one year) investments.

Property, Plant & Equipment: These are the company's major physical assets, including such things as buildings, factory machines, vehicles, and large computer systems. The cost of these assets is normally charged against income as depreciation expense across the depreciable life of the asset. Note that each year of the asset's depreciable life, the depreciation expense contributes to accumulated depreciation, reducing the "book value" of the asset on the balance sheet.

Intangible Assets: Assets which cannot be seen or touched, but which arguably are (a) owned by the company, which has exclusive rights to them, and (b) contribute to earning ability. These may include copyrights and patents, trademarks, "brand image:" and "goodwill."

On the Liabilities and Equities side of the balance sheet, the major categories are:

Current Liabilities: These are generally described as the obligations the company has that must be met within a short time, such as one year or less. They may include such things as accounts payable, the current portion of long term debt that is due, and estimated short term warranty obligations.

Long Term Liabilities: These are obligations that are not due immediately, but due instead for a period longer than one year. Long term liabilities may include bank notes payable, bonds payable, or long term financing arrangements for purchases.

Contributed Capital: One of the two main categories on the balance sheet under owner’s equity (the other is retained earnings). Contributed capital shows what has been invested by stockholder’s through purchase of stock from the corporation (not through purchase of stock on the open market from other stockholders). Contributed capital, in turn, has two main components: Stated capital, which represents the stated, or par value of the shares, and additional paid-in capital, which represents money paid to the company above the par value.

Retained earnings: The part of a company’s income kept to accumulate, after dividends are paid. The company’s accumulated retained earnings appear on the balance sheet under owner’s equity .After a profitable period, a company can (at the discretion of its board of directors) pay some of its income to shareholders, as dividends, and keep the remainder as retained earnings.

Balance Sheet Contributions to Financial Statement Metrics and Ratios

The balance sheet is a primary source for input into financial metrics and financial statement ratios that address questions like these:

Is the company prepared to meet its short term financial obligations?
Liquidity metrics such as current ratio address questions of that kind.
Is the company using its resources efficiently?
Activity metrics such as inventory turns are designed for such questions.
Are the company's funds supplied primarily by owners or by creditors?
Leverage metrics, such as debt to asset ratio provide answers
Is the company profitable? Is it making good use of its assets?
Profitability metrics such as operating margin address such questions.
What are the company's prospects for future earnings?
Valuation metrics, e.g., price to earnings ratio deal with such questions.
How does the company's growth over the last five years compare to
similar companies? To industry averages?
Growth metrics such as the cumulative average growth rate for sales

Financial statement metrics are generally used by…

Investors considering buying or selling stock or bonds in a company.
Company management, for identifying strengths, weaknesses, and target levels for business objectives. \
Shareholders and boards of directors, for evaluating senior management.

For a complete introduction to these financial statement metrics, along with working spreadsheet examples and templates, see Financial Metrics Pro^TM.

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