A balance sheet communicates the value of a business’ assets, liabilities and shareholder equity at a particular point in time. Assets include goods and resources that can be turned into cash, while liabilities represent debts and investments.
A strong balance sheet indicates that you own more than you owe, and shows lenders that your company is solvent. A strong balance sheet is also key for attracting investors and buyers.
The left side of a balance sheet shows what a company owns (assets) and the money it owes (liabilities). These resources include cash and cash equivalents such as certificates of deposit, as well as accounts receivable, which is what customers owe to a business after buying goods or services on credit. It also includes inventory and other raw materials used to produce products or services.
Assets are classified based on their convertibility into cash, with the most liquid assets appearing first. They are grouped into current and noncurrent assets. Current assets are those that can be turned into cash within a year, such as inventories and accounts receivable. Noncurrent assets are those that cannot be turned into cash, including property, plant and equipment (PP&E) and intangible assets such as trademarks, copyrights and goodwill.
Liabilities are grouped into current and long-term obligations. Long-term obligations are those due more than a year from now. Shareholders’ equity is the remainder of a company’s funds after subtracting its liabilities from its assets.
As the name suggests, liabilities represent debts and obligations owed to outside parties. They typically include accounts payable, taxes and wages. They are categorized as current or long-term depending on their temporality. In the case of accounts payable, any amounts that are owed within the next year will be recorded as a current liability while any amount that is owed in ten years or more will be accounted for as a long-term liability.
Companies also record accrued expenses, deferred tax expense and warranties as liabilities on their balance sheets. Contingent liabilities are potential risks that may or may not affect the company in the future, and are recorded only when their impact can be reasonably estimated.
In accounting terms, the right and left sides of a balance sheet must always match each other. This is because shareholders’ equity must always equal assets minus liabilities. This is a fundamental principle of double-entry bookkeeping. It helps ensure that the company’s financial statements are always accurate and reliable.
Shareholders’ equity (also referred to as stockholders’ capital or owners’ capital) represents the value of a company’s assets that belong to its investors and shareholders. It is calculated as a company’s total assets minus its total liabilities. It is reported under the shareholders’ equity section of a balance sheet and can be broken down into several components. These include contributed capital, treasury shares, retained earnings, and other comprehensive income.
Contributed capital refers to money paid into the company by shareholders in exchange for ownership, along with any unrealized gains or losses on investments. Retained earnings are the accumulated profits that a company does not distribute to its shareholders, and include net income for the period minus dividends paid out during that same period. Treasury shares are stock that the company has repurchased from its investors and is not in circulation. The resulting figure is subtracted from total assets to reveal the amount of total shareholders’ equity.
Notes to the Financial Statements
While a balance sheet is one of the most useful pieces of financial reporting, it cannot paint a complete picture of a company’s business activities. Other reports, such as the income statement and a statement of cash flows, combine information found on the balance sheet with other accounting principles to provide a fuller understanding of how earnings are calculated.
The notes section of a balance sheet includes important details about the accounts listed on the report. These include details about where revenue comes from, payment terms and amounts allocated for refunds or warranties. The notes also discuss the assumptions made by accountants about a company’s ability to continue as a going concern, which is the basis of the current valuation of a business.
The next section of the balance sheet lists liabilities and shareholders’ equity. As with the assets column, accounts are broken down into current and non-current liabilities and separated by account type. Current liabilities include a company’s debt repayments, recurring expenses and the current portion of longer-term borrowings.Bilanz