Business Finance 101 – The Balance Sheet or Statement of Financial Position

Business Finance 101 – The Balance Sheet or Statement of Financial Position
The Balance Sheet or Statement of Financial Position

The balance sheet is also referred to as the statement of financial position.

It presents a company’s financial position at the end of a particular date, also known as a “snapshot” of the company’s financial position at a point (a moment or an instant) in time. For example, the amounts reported on a balance sheet dated December 31, 2012 reflect that day when all the transactions up to December 31 have been recorded.

Because the balance sheet informs the reader of a company’s financial position as of one moment in time, it allows someone like a creditor like a lender to see what a company owns as well as what it owes to other parties as of the date indicated in the heading. This is invaluable information to the banker who wants to determine whether or not a company could qualify for additional credit or loans. Others who would be interested in the balance sheet include current investors, potential investors and company management.

The Balance sheet has 3 main parts – Assets, Liabilities and Equity.

Assets are what that the company owns. They are the resources of the company that have been acquired through transactions, and have future value that can be measured and expressed in dollars. Assets may also include costs paid in advance that have not yet expired, such as prepaid advertising, insurance, legal fees, and rent, especially in accrual accounting.

The balance sheet accounts are presented in distinct groupings, categories, or classifications. The asset classifications and their order of appearance on the balance sheet are:

Current – bank account balances, cash, inventory, debtors/accounts receivable, and

Non-Current (or Long-Term) – plant & equipment, property, goodwill

Liabilities are obligations of the company; they are amounts owed to creditors for a past transaction and they usually have the word “payable” in their account title. Along with owner’s equity, liabilities can also be thought of as a source of the company’s assets, or thought of as a claim against a company’s assets. For example, a company’s balance sheet reports assets of $50,000 and Accounts Payable of $20,000 and owner’s equity of $30,000. The source of the company’s assets are creditors/suppliers for $20,000 and the owners for $30,000. The creditors/suppliers have a claim against the company’s assets and the owner can claim what remains after the Accounts Payable have been paid.

Liabilities may also include amounts received in advance for future services, where the amount received (recorded as the asset Cash) has not yet been earned, the company defers the reporting of revenues and instead reports a liability such as Unearned Revenues or Customer Deposits.

As assets are classified, so are liabilities form 2 main groups

Current – overdrafts, accounts payable to be paid by the business, short loans such as credit cards and less than 12 month loans, tax, payroll and super to be paid soon

Non-Current or Long-Term – loans and finance longer than 12 months

Equity – along with liabilities – can be thought of as a source of the company’s assets. Owner’s or Stockholder’s equity is sometimes referred to as the book value of the company, because owner’s equity is equal to the reported asset amounts minus the reported liability amounts.

Equity may also be referred to as the residual of assets minus liabilities. These references make sense if you think of the basic accounting equation:

Assets less Liabilities = Equity

Owner’s Equity” are the words used on the balance sheet when the company is a sole proprietorship. If the company is a corporation, the words “Stockholders’ Equity are used instead of Owner’s Equity. Examples of stockholders’ equity accounts include: Common and preferred stock, Retained Earnings.

Special Note – the asset amounts report the cost of the assets at the time of the transactionor lessthey do not reflect current fair market values. (For example, computers which had a cost of $10,000 two years ago may now have a written down value of $6,000 (cost less depreciation). However, the current re-sell value of the computers might be just $3,000. An office building purchased by the company 15 years ago at a cost of $400,000 may now have a book value of $200,000. However, the current value of the building might be $900,000.) Since the assets are not reported on the balance sheet at their current fair market value, owner’s equity appearing on the balance sheet is not an indication of the fair market value of the company.

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