Financial Statements - What Is the Balance Sheet?

This is the second article in a series of articles about the different financial statements. As we had mentioned in the last article, financial statements are the bridge that let the stakeholders know what is going on within a company. They make it easier for investors, buyers, competitors, customers and many other stakeholders to see how well the company is performing. In this article we will take a closer look at the balance sheet. The balance sheet is one of the most important financial statements of a company. While the income statement reports on all financial activities a company conducts within a period. The balance sheet reports on the general health of a company at a particular point in time (not during a period). The balance sheet is especially helpful for financial analysts. There are a few ratios that enable the financial analyst to see how well the company is managing, its receivables, payables, debt, cash, and other important aspects of the company.

The balance sheet is made up of three major sections: Assets, Liabilities, and Equity (or Stockholders equity).

Assets

The assets of a company are items owned by the company which have value and are usually something for which money was paid. This main category will be further divided into different types of assets (cash, receivables, current assets, property etc).

Liabilities

Liabilities of a company are those items that the company owes to other entities whether they be businesses, individuals, or even governments. Liabilities can also be further divided into different types of liabilities (current liabilities, long term liabilities, etc).

Equity (Stockholders Equity)

This is the third main section of the balance sheet. It includes amounts that the owners, or investors have invested into the business. This will also include part of the profit that the company chooses to retain and reinvest in new projects.

In accounting you will often find the concept of matching. Accountants and financial analysts use this concept for a range of uses including forensic accounting, financial analysis. Even the most common tasks such as reconciliation of accounts uses the balance sheet as an integral source of information. In the balance sheet, the assets must equal the sum of all the liabilities and stockholder's equity (hence the name balance sheet). This rule can never be broken.

This equation is simply written as: Assets = Liabilities + Equity (A = L + E)

In later articles we will go over some of the parts of each side in more detail. For example we will go over Accounts Receivable, Inventory, Accounts Payable etc and the different peculiarities of each item. Before we end the article, we must explain a concept. In accounting information is very integral to running the company. The more information provided about certain accounts or transactions the better. In that line, we can see in all balance sheets that the assets and liabilities are further divided into short term and long term assets or liabilities (also current and non current). In terms of assets, all current or short term assets are those that can easily be converted (or are expected to be converted) to cash. Usually companies put a marker such as one month or 90 days. So all assets that are going to be converted to cash or liquid securities within that time frame will be put into short term or current assets. The same goes for liabilities. All liabilities that are due within 90 days (or one year for some companies) will be classified as short term liabilities. In fact all notes due are automatically considered as short term because they are due within that year. We will further clarify these in later articles along with ratios that analysts use to gauge the health of the company.