What is the Balance Sheet?
Balance sheet is one of the financial statements of the company which presents the shareholders’ equity, liabilities and the assets of the company at a particular point of time and is based on accounting equation which states that the sum of the total liabilities and the owner’s capital is equal to the company’s total assets.
Balance Sheet is the “Snapshot” of a company’s financial position at a given moment and reports the amount of a company’s
- Assets – Current assets/Long-term assets
- Liabilities – Current Liabilities/Long-term liabilities
- Stockholders’ (or owner’s) equity – Common stock / Retained earnings
Remember the most important equation while forming the Balance Sheet –
Assets = Liabilities + Shareholders’ Equity
Let’s get started.
- Unlike Income Statement, Balance Sheets are much less complicated (however, there are many items you need to include under few heads). And It portrays the overall picture of a company’s financial affair altogether.
- Balance Sheets can’t be formed without first setting up the income statement because we need to know the retained earnings from the income statement. Through Income Statement, we can ascertain the net profit. The portion of net profit that is not distributed among the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. is called “retained earnings.”
Balance Sheet Structure
Assets are arranged on the left-hand side, and the liabilities and shareholders’ equity EquityShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders' Equity Statement on the balance sheet details the change in the value of shareholder's equity from the beginning to the end of an accounting period. would be on the right-hand side. However, in most cases, companies put the assets first, and then they set up liabilities and at the bottom shareholders’ equity. The total assets should be equal to the total liabilities and total shareholders’ equity.
Assets = Liabilities + Shareholders’ Equity
Balance Sheet Format is as follows –
- Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.
- Current Liabilities
- Long Term Assets
- Long Term LiabilitiesLong Term LiabilitiesLong Term Liabilities, also known as Non-Current Liabilities, refer to a Company’s financial obligations that are due for over a year (from its operating cycle or the Balance Sheet Date).
- Shareholder’s Equity
#1 – Current Assets
Current assets are expected to be consumed, sold, or converted into cash either in one year or in the operating cycleOperating CycleThe operating cycle of a company, also known as the cash cycle, is an activity ratio that measures the average time required to convert the company's inventories into cash., whichever is longer. An operating cycle is an average time it takes to convert investment in inventory back into cash. Current assets are presented in order of liquidityOrder Of LiquidityThe presentation of various assets in the balance sheet with the time it takes for each to be converted into cash is known as the order of liquidity. Cash is considered a most liquid asset, followed by cash equivalents, marketable securities, account receivables, inventories, non-current investments, loans and advances, fixed assets.
Assets are arranged on the basis of how quickly they can be converted into cash (means how liquid they are). That means, in the balance sheet, the first things we will put in our current assets. Under current assets, these are the items you can consider –
- Cash & Cash Equivalents – Cash could also include an amount required to be held for deposit to satisfy the terms of a lending agreement. Cash equivalents are securities (e.g., US Treasury billsTreasury BillsTreasury Bills or a T-Bill controls temporary liquidity fluctuations. The Central Bank is responsible for issuing the same on behalf of the government. It is given at its redemption price and a discounted rate and is repaid when it reaches maturity.) that have a term of less than or equal to 90 days. Also, have a look at this detailed article on Cash and Cash EquivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset.
- Short-term investments – Short Term Marketable SecuritiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it. primarily includes Bond Investments and Capital Stock InvestmentsCapital Stock InvestmentsThe capital stock is the total amount of share capital (including equity capital and preference capital) that has been issued by a company. It is a way of raising funds by the company to meet its various business goals.. Short-Term Marketable Securities are not as ready as money in your account, but they provided added cushion if some immediate need were to arise
- Inventories – Inventory consists of merchandise a business owns but has not sold. Classified as current assets because investor assumes that inventory can be sold in the near future, turning it into cash. Also, have a look at Types of InventoriesTypes Of InventoriesDirect material inventory, work in progress inventory, and finished goods inventory are the three types of inventories. The raw material is direct material inventory, work in progress inventory is partially completed inventory, and finished goods inventory is stock that has completed all stages of production.
- Trade & Other Receivables – Money that is owed to the company by the customers
- Prepayments & Accrued IncomeAccrued IncomeAccrued Income is that part of the income which is earned but hasn't been received yet. This income is shown in the balance sheet as accounts receivables. – Sometimes, a business will have to pay for goods or services before they actually receive the product. Expenses that have been paid in the current fiscal period but that will not be subtracted from revenue until a subsequent fiscal period
Other current assets also include Derivative Assets, Current Income Tax Assets, Assets Held for Sale, etc.
Current Assets will look like following –
|Particulars||X (in US $)||Y (in US $)|
|Total Current Assets||12500||14500|
#2 – Current Liabilities
Current Liabilities are probable future payments of assets or services that a firm is obligated to make as a result of previous operations. These obligations are expected to require the use of existing current assets or the creation of other current liabilities.
“Current Liabilities” generally include the following –
- Accounts Payable – Amounts owed to suppliers for goods and services that have been purchased on credit. Accounts payable Accounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period. are debts that must be paid off within a given period of time in order to avoid default.
- Short Term Debt – Short Term Debt is also referred to as Notes PayableNotes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. . Sometimes when the demand is high, a company may raise short-term loans to stock up the inventory (Utilizing leverage)
- Current Maturities of Long-Term Debt – Any portion of long-term debt that is to be repaid within a year of the balance sheet date is reclassified from the noncurrent liability section to the current liability section of the title, current maturities of long-term debtCurrent Maturities Of Long-term DebtCurrent Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets.
- Unearned Revenues – Unearned revenue is created when customers pay for services or products before delivery.
- Other Accrued LiabilitiesAccrued LiabilitiesAccrued liabilities refer to the obligations against expenses which the company incurs over one accounting period; however, it has not made any monetary payment for such expenses in the same accounting period. These expenses appear as liabilities in the corporate balance sheet. – This could include Money owed to employees as salary and bonus that the company has not yet paid
Other than that, current liabilities also include accounts payable, sales taxes payable, income taxes payable, interest payableInterest PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company's balance sheet., bank overdrafts, payroll taxes payable, customer deposits in advance, accrued expenses, short-term loans, current maturities of long-term debt, etc.
Current Liabilities will look like following –
|Particulars||X (in US $)||Y (in US $)|
|Current Taxes Payable||5000||6000|
|Current Long-term Liabilities||11000||9000|
|Total Current Liabilities||20000||18000|
#3 – Long Term Assets
Long term assets are typically physical assets that the company owns and are employed in the production process of the firm and have a useful life greater than one year. Long term assets are not for sale to the firm’s customers (they are not inventory!)
Long-term assets can be classified into three main categories
- Tangible Assets: These assets have a physical existence. Assets like Real Estate, Buildings, Offices, Machinery, Furniture, Telephone belong to this category. The process of allocating the cost of tangible assetsTangible AssetsAny physical assets owned by a firm that can be quantified with reasonable ease and are used to carry out its business activities are defined as tangible assets. For example, a company's land, as well as any structures erected on it, furniture, machinery, and equipment. over the useful life is called “depreciation” (we will discuss this later)
- Natural Resources: These assets have an economic value derived from Earth and used up over time. Examples include Oil fields, mines, etc
- Intangible Assets: These assets have no physical existence, and they cannot be felt or touched or seen. Examples include trademarks, copyrights, patents, franchises, and goodwill. The cost of intangible assets is allocated to periods over which it provides benefits through a process called amortization (have a look at this detailed article on GoodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.)
Long term assets are generally reported at their carrying valueCarrying ValueCarrying value is the book value of assets in a company's balance sheet, computed as the original cost less accumulated depreciation/impairments. It is calculated for intangible assets as the actual cost less amortization expense/impairments. or book value. If the asset has lost its revenue-generating ability it may be written down (asset impairment) amount of written down is recorded as a loss
#4 – Long Term Liabilities
Long-Term Liabilities are obligations that are not expected to require the use of current assets or not expected to create current liabilities within one year or the normal operating cycle (whichever is longer).
- In most cases, it contains long-term debt. Long-term debt is subject to various covenantsCovenantsCovenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. It is a standard clause of the bond contracts and loan agreements. or restrictions. Long-term debt can be obtained from many sources and may differ in the structure of interest, and principal paymentsPrincipal PaymentsThe principle amount is a significant portion of the total loan amount. Aside from monthly installments, when a borrower pays a part of the principal amount, the loan's original amount is directly reduced. and the claims creditors have on the assets of the firm.
- Bonds are contracted between the borrowers and the lender that obligates the bond issuer to make payments to the bondholder over the life of the bond
- Creditors claims could be subdivided into two types:
#5 – Shareholder’s Equity
Stockholders’ Equity is the residual interest of the stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares. in the assets of the corporation. There are two primary sources of Equity – Paid-in Capital and Retained Earnings
Each share of common stock conveys certain rights to the
- Attend stockholders’ meetings
- Elect directors and vote on other matters
- Receive dividends as declaredDividends As DeclaredDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities. by the board of directors
- Preemptive right: The preemptive right is a shareholder’s right to purchase a proportionate amount of
any new stock issued at a later date
Shareholder’s Accounts need to be maintained for
- Par Value (Par value has no economic significance)
- Additional Paid-in CapitalAdditional Paid-in CapitalAdditional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market.
Preferred stock has certain preferences or features not possessed by common stock
How to read the Balance Sheet?
As an investor, you need to know how to read the Balance SheetHow To Read The Balance SheetReading and understanding the balance sheet of the company includes consideration of the accounting equation, knowing different types of assets, shareholders equity and liabilities of the company and analyzing the balance sheet using ratios. to be able to extract the most of it.
These are the steps that can help you read it –
- The first thing is really the first thing. You need to know the balance sheet equation. You need to see whether the total assetsTotal AssetsTotal Assets is the sum of a company's current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equity and total liabilities & total shareholders’ equity are equal. Assets = Liabilities + Equity
- Then you will look at the current assets. These assets will give ideas about the liquidity of the company and where the company expects to liquidate the assets. These assets can easily be converted into cash.
- Then you should follow the non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark., which include fixed assets and intangible assets (like patents, etc.) as well. You need to find out the wear and tear (depreciation) and other expensesExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities. and whether they have been taken into account or not. Match it up with the income statement and cash flowCash FlowStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities. statement to understand whether there is any loophole or not.
- Then you need to learn about the liabilities of the company. They can be both current and non-current. Current liabilities are items that can be dealt with quickly, and the keyword for it is “short term.” In the case of non-current liabilitiesCase Of Non-current LiabilitiesThe most common examples of Non-Current Liabilities are debentures, bond payables, deferred tax liabilities etc. Non-Current Liabilities are the payables or obligations of an entity which might not be settled within twelve months of accounting such transactions. , it takes longer for the firm to pay off, which includes long-term loans and other payables.
- The last step is to look through the shareholders’ equity. Check out the retained earnings and compare it with a net profit. And you will get an idea about how much dividend is being paid (if any).
- It is important for you to know that you shouldn’t skip any step mentioned above. Don’t look at shareholders’ equity until you have completed looking at all other items in the balance sheet. The best way is to keep a pen and paper and take notes while looking through the items and matching them up with the other financial statements.
Balance Sheet Example (Colgate Case Study)
# 1 – Current Assets
- Cash and Cash Equivalents of Colgate was $970 million in 2015 and $1089 in 2014.
- Accounts receivables net of the allowanceAccounts Receivables Net Of The AllowanceAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet. was $1427 million in 2015 and $1552 million in 2014.
- We note that around 45% of current assets in 2015 consists of Inventories and Other Current Assets. This may affect the liquidity position of Colgate.
- When investigating Colgate’s inventory, we note that the majority of the Inventory consists of Finished GoodsInventory Consists Of Finished GoodsFinished goods inventory refers to the final products acquired from the manufacturing process or through merchandise. It is the end product of the company, which is ready to be sold in the market. (which is better in liquidity than raw materials supplies and work-in-progress).
# 2 – Current Liabilities
- Colgate’s Accounts payable stands at $1110 million in 2015 and $1231 million in 2014
- Current Portion of Long-term debt was at $298 million in 2015 and $488 million in 2014.
- Accrued Income Taxes was at $277 in 2015 and $294 million in 2014.
- Other accruals are close to 50% of the Total Current Liabilities.
#3 – Long Term Assets
- Long-term assets in Colgate’s BS include the Property, Plant and Equipment, Goodwill, Other Intangible Assets, Deferred Income TaxesDeferred Income TaxesDeferred income tax is a balance sheet item that can be either a liability or an asset since it is a difference in income recognition between the firm's accounting records and the tax law, resulting in the company's income tax due being different than the total tax expense reported., and Other Assets
- Property Plan and Equipment is the largest item in Colgate’s Long Term Assets. It includes Land, Buildings, Manufacturing machinery, and equipment, etc.
- Goodwill and other intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. are also high in Colgate. Goodwill and indefinite life intangible assets, such as the Company’s global brands, are subject to goodwill impairment tests at least annually
#4 – Long Term Liabilities
- Long-Term Liabilities in Colgate’s BS include the Long Term Debt, Deferred Income Taxes, and Other liabilities.
- The weighted average interest rate on the Long-term debt is approximately 2.1%
- Colgate’s Long Term Debt (including the current portion) increased to $6567 million in 2015 as compared to $6132 million in 2014.
- Other liabilities primarily include Pension and other retiree benefits and restructuring accrual
#5 – Shareholder’s Equity
- Shareholder’s Equity in Colgate’s BS includes Common Stock, Additional Paid-in Capital, Retained Earnings, Accumulated Other Comprehensive Income, Unearned compensation, and Treasury stocksTreasury StocksTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. .
- Treasury stocks are those stocks that Colgate buys back as a part of its Share Buyback agreementShare Buyback AgreementShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.. You may note that Shareholder’s equity of Colgate is negative primarily due to its share buyback.
- Colgate’s Accumulated other comprehensive income is at -3950 million in 2015 and -3507 million in 2014.
Also, you can check that Colgate’s Assets = Liabilities + Shareholders’ Equity.
Balance Sheet Example – Vertical Analysis
For understanding Colgate’s Balance sheet trends over the period of time, we can perform Vertical AnalysisVertical AnalysisVertical analysis is a kind of financial statement analysis wherein each item in the financial statement is shown in percentage of the base figure. The formula is: (Statement line item / Total base figure) X 100. Vertical Analysis normalizes the Balance Sheet and expresses each item in the percentage of total assets/liabilities. It helps us to understand how each item sheet has moved over the years.
- For each year, Balance Sheet line items are divided by its respective year’s Top Assets (or Total Liabilities) number.
- For example, for Accounts Receivables, we calculate as Receivables / Total Assets. Likewise for other balance sheet itemsBalance Sheet ItemsAssets such as cash, inventories, accounts receivable, investments, prepaid expenses, and fixed assets; liabilities such as long-term debt, short-term debt, Accounts payable, and so on are all included in the balance sheet.
- Cash and Cash equivalents have increased from 4.2% in 2007 and are currently standing at 8.1% of the total assets.
- Receivables had decreased from 16.6% in 2007 to 11.9% in 2015.
- Inventories have decreased too, from 11.6% to 9.9% overall.
- What is included in “other current assets”?Other current assets refer to the category of assets which record all the uncommon and insignificant assets readily convertible into cash and doesn't fit in any common current assets categories like cash & cash equivalents, inventory, trade receivables, etc. It shows a steady increase from 3.3% to 6.7% of the total assets over the last 9 years.
- On the liabilities side, there can be many observations we can highlight. Accounts payable decreased continuously over the past 9 years and currently stands at 9.3% of the total assets.
- There has been a significant jump in the Long-Term Debt to 52,4% in 2015. For this, we need to investigate its SEC FilingsSEC FilingsSEC filings are formal documents submitted to the Securities and Exchange Commission in the United States that contain financial information about the company as well as any other relevant information about recent or upcoming activities. further.
- Non-controlling interestsNon-controlling InterestsIt generally projects curves on the data sets. For example, to forecast population growth, forming a non-linear relationship between time and growth. have also increased over the period of 9 years and are now at 2.1%
Learning to read a balance sheet is important if you want to be successful as an investor. And it starts with pulling out a balance sheet of a company and reading it through and through. If it’s your first annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements. reading, then please do not get intimidated. Stay put. You will master the financial analysis over a period of time.
Video on Balance Sheet
This has been a guide to What is Balance Sheet? Here we discuss balance sheet structure, Assets = Liabilities + Equity, Balance Sheet Analysis using practical examples of Colgate, etc. You may learn more about accounting from the following articles –