Assets = Liabilities + Shareholders' Equity
Assets = Liabilities + Shareholders' Equity
The balance sheet is one of the three fundamental financial statements and is key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. It can also sometimes be referred to as a statement of net worth, or a statement of financial position. The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity
As such, the balance sheet is divided into two sides (or sections). The left side of the balance sheet outlines all a company’s assets. On the right side, the balance sheet outlines the companies liabilities and shareholders’ equity. On either side, the main line items are generally classified by liquidity. More liquid accounts like Inventory, Cash, and Trades Payables are placed before illiquid accounts such as Plant, Property and Equipment (PP&E) and Long-Term Debt. The assets and liabilities are also separated into two categories: current asset/liabilities and non-current (long-term) assets/liabilities.
Below is an example of Amazon’s 2016 balance sheet. As you will see, it starts with current assets, then non-current assets and total assets. Below that is liabilities and stockholders’ equity which includes current liabilities, non-current liabilities, and finally shareholders’ equity.
View Amazon’s investor relations website to view the full balance sheet and annual report.
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Balance sheets, like all financial statements, will have minor differences between organizations and industries. However, there are several “buckets” and line items that are almost always included in common balance sheets. We briefly go through commonly found line items under Current Assets, Long-Term Assets, Current Liabilities, Long-Term Liabilities and Equity.
The most liquid of all assets, cash, appears on the first line of the balance sheet. Cash Equivalents are also lumped under this line item and include assets that have short-term maturities under three months or assets that the company can liquidate on short notice, such as marketable securities. Companies will generally disclose what equivalents it includes in the footnotes to the balance sheet.
This account includes the balance of all sales revenue still on credit, net of any allowances for doubtful accounts (which generates a bad debt expense). As companies recover accounts receivables, this account decreases and cash increases by the same amount.
Inventory includes amounts for raw materials, work-in-progress goods and finished goods. The company uses this account when it reports sales of goods, generally under cost of goods sold in the income statement.
Property, Plant and Equipment (also known as PP&E) capture the company’s tangible fixed assets. This line item is noted net of depreciation. Some companies will class out their PP&E by the different types of assets, such as Land, Building, and various types of Equipment. All PP&E is depreciable except for Land.
This line item will include all of the companies intangible fixed assets, which may or may not be identifiable. Identifiable intangible assets include patents, licenses, and secret formulas. Unidentifiable intangible assets include brand and goodwill.
Accounts Payables, or AP, is the amount a company owes suppliers for items or services purchased on credit. As the company pays off their AP, it decreases along with an equal amount decrease to the cash account.
Includes non-AP obligations that are due within one year time or within one operating cycle for the company (whichever is longest). Notes payable may also have a long-term version, which includes notes with a maturity of more than one year.
This account may or may not be lumped together with the above account, Current Debt. While they may seem similar, the current portion of long-term debt is specifically the portion due within this year of a piece of debt that has a maturity of more than one year. For example, if a company takes on a bank loan to be paid off in 5-years, this account will include the portion of that loan due in the next year.
This account includes the amortized amount of any bonds the company has issued.
This account includes the total amount of long-term debt (Excluding the current portion, if that account is present under current liabilities). This account is derived from the debt schedule, which outlines all the companies outstanding debt, the interest expense and the principal repayment for every period.
This is the value of funds that shareholders have invested in the company. When a company is first formed, shareholders will typically put in cash. For example, an investor starts a company and seeds it with $10M. Cash (an asset) rises by $10M, and Share Capital (an equity account) rises by $10M, balancing out the balance sheet.
This is the total amount of net income the company decides to keep. Every period, a company may pay out dividends from its net income. Any amount remaining (or exceeding) is added to (deducted from) retained earnings.
This statement is a great way to analyze a company’s financial position. An analyst can generally use the balance sheet to calculate a lot of financial ratios that can determine how well a company is performing, how liquid or solvent a company is, and how efficient it is.
Changes in balance sheet accounts are also used to calculate cash flow in the cash flow statement. For example, a positive change in plant, property, and equipment is equal to capital expenditure minus depreciation expense. If depreciation expense is known, capital expenditure can be calculated and included as a cash outflow under cash flow from investing in the cash flow statement.
Screenshot from CFI’s M&A Modeling Course.
The balance sheet is a very important financial statement for many reasons. It can be looked at on its own, and in conjunction with other statements like the income statement and cash flow statement to get a full picture of a company’s health.
4 important takeaways include:
All of the above ratios and metrics are covered in detail in CFI’s Financial Analysis Course.
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