Introduction

The Balance Sheet is a financial statement that reports a company’s financial position at a specific point in time (e.g., “as of December 31, 2023”). Unlike the income statement, which shows performance over a period, the balance sheet is a still picture. It answers the fundamental question: “What does the company own, and how does it pay for it?”

Fundamental Equation

The entire balance sheet is built upon one immutable identity:

Assets = Liabilities + Shareholders' Equity

• Assets: Resources owned or controlled by the company that are expected to provide future economic benefit (e.g., cash, inventory, property, patents).
• Liabilities: Obligations or debts the company owes to outsiders (e.g., bank loans, accounts payable, bonds).
• Shareholders’ Equity: Also called “net assets” or “book value.” It represents the owners’ residual claim on assets after all liabilities are paid. It consists primarily of:
  • Contributed Capital: Money invested by shareholders.
  • Retained Earnings: Cumulative net income kept in the business (not paid out as dividends).

Key Insight: This equation must always balance. Every financial transaction affects at least two accounts to maintain this equilibrium (the concept of double-entry bookkeeping).

Deconstructing The Balance Sheet

Assets (In order of liquidity)

Listed in order of how quickly they can be converted to cash.

1. Current Assets: Expected to be used/sold/converted to cash within one year or the operating cycle.
   • Cash & Cash Equivalents
   • Marketable Securities
   • Accounts Receivable
   • Inventory
   • Prepaid Expenses
2. Non-Current (Long-Term) Assets: Provide benefit for more than one year.
   • Property, Plant & Equipment (PP&E) (net of depreciation)
   • Long-term Investments
   • Intangible Assets (patents, trademarks, goodwill)

Liabilities (In order of maturity)

Listed in order of when they are due.

1. Current Liabilities: Due within one year or the operating cycle.
   • Accounts Payable
   • Short-term Debt
   • Accrued Expenses (wages, taxes payable)
   • Unearned Revenue
2. Non-Current (Long-Term) Liabilities: Due after one year.
   • Long-term Debt (bonds, mortgages)
   • Deferred Tax Liabilities
   • Pension Obligations

Shareholders’ Equity

• Common Stock & Additional Paid-In Capital: The direct investment by shareholders.
• Retained Earnings: Profits reinvested in the business.
• Treasury Stock: (A contra-equity account) The company’s own stock it has repurchased.
• Accumulated Other Comprehensive Income: Certain unrealized gains/losses (e.g., on foreign currency translation).

What can we see here?

A balance sheet is the starting point for key financial ratios and assessments:

• Liquidity Analysis: Can the company meet its short-term obligations?
  • Tool: Current Ratio = Current Assets / Current Liabilities
  • Insight: A ratio < 1.0 may signal potential cash flow problems.
• Solvency & Financial Structure: How is the company financed? Is it overly reliant on debt?
  • Tool: Debt-to-Equity Ratio = Total Liabilities / Shareholders’ Equity
  • Insight: A higher ratio indicates greater financial leverage and risk.
• Working Capital Management: How efficiently is the company managing its short-term assets and liabilities?
  • Tool: Working Capital = Current Assets – Current Liabilities
  • Insight: Positive working capital is typically necessary for operational health.

Limitations

• Historical Cost: Most assets are recorded at their original purchase price, not current market value (e.g., land purchased decades ago).
• Intangibles: Critical assets like brand value, human capital, and intellectual property (unless purchased) are often not fully captured.
• Snapshot Nature: It can change rapidly the day after the reporting date.

Summary

• The balance sheet is a point-in-time statement of financial position.
• It is governed by the equation: Assets = Liabilities + Equity.
• It provides the raw data to assess liquidity, solvency, and capital structure.
• It is most powerful when analyzed over time (trend analysis) and in conjunction with the income and cash flow statements.