The balance sheet provides us with a financial snapshot of our business for a certain point in time. It tells us what our assets are, what our liabilities are, and what our equity (net worth of company) is. The balance sheet is only valid for one point in time. For example if the balance sheet is date September 30, 2012, the balance sheet would only be valid for September 30. It would not be valid for September 29 or October 1. It is only valid for September 30.
Why is it called a Balance Sheet. Because it balances. If it didn’t balance, it would not be called a Balance Sheet.
One of the fundamentals of accounting is the Accounting Equation:
Assets = Liabilities and Equity.
When we look at a Balance Sheet, the assets will always equal the liabilities and equity section.
The balance sheet has two major sections the Assets section and the Liabilities and Equity Section.
In the Assets section, you have three main categories: Current Assets, Fixed Assets, and Other Assets. Current assets are assets that a company will convert to cash or use in operations within one year. Examples of this are cash, marketable securities, and accounts receivable.
Fixed Assets are assets that have a useful life longer than 12 months. A good example of this is a vehicle. Useful life of a vehicle is 5 years. Let’s say the vehicle was bought for $20,000, then the company would expense or depreciate the cost of the vehicle over the five year period. Each year the company would recognize depreciation expense for that vehicle equal to $4,000 (20,000 / 5 years = $4,000 depreciation expense per year).
Other Assets of the company would include intangible assets. Examples of intangible assets include software, goodwill, and loan costs. These intangible assets are similar to fixed assets. They have a useful life that is more than 12 months. The company will expense or amortize the cost of the intangible assets over the useful life of the asset.
The Liabilities section of the balance sheet contains current liabilities and long-term liabilities. Current liabilities are liabilities that would need to be paid within the next 12 months. Long-term liabilities will need to be paid following the next 12 months. If a company has a long term loan, the company would need to figure out how much of that loan is going to be due over the next twelve months. Once it has determined the amount due, it would move the current portion of long term debt from the long term liabilities section to the short term liabilities section.
The final section of the balance sheet is the equity section. Example of equity would include common stock, additional paid in capital and retained earnings. The retained earnings are earnings from prior years that the company did not distribute to the owners of the company.