The balance sheet is one of the most crucial financial statements for a business, showing the financial position of a company at a given time. As such, this statement is otherwise referred to as the statement of financial position. This article discusses the balance sheet in detail, with emphasis on the various components of the statement.
Components of the balance sheet
The balance sheet states the financial position of a company as of the end of a particular reporting period (while other items like the statement of cash flows and the income statement cover every bit of the reporting period). Such statements are crucial when determining the performance of a business at every point of the reporting period.
The balance sheet specifically zeroes in on the liquidity status of the company at the end of the reporting period. As such, the financial statement is crucial for investors and creditors when they need to make a decision concerning their relationship with a given business.
The balance sheet consists of three main components: assets, liabilities, and shareholder equity.
Assets refer to items under a company’s ownership that can be converted to cash. Usually, the balance sheet captures both current and non-current assets. In case of the current financial position, the balance sheet will capture current assets.
- Current assets – This includes short-term assets such as accounts receivable, inventories, cash and cash equivalents, accrued revenue, and prepaid expenses.
- Non-current assets – This category entails assets that cannot be converted to cash easily. Non-current assets are long-term, and businesses maintain them with the intention of utilizing them for their day-to-day operations. Oftentimes, the benefits of these assets accrue for several years. The assets can be tangible or intangible, and they provide a great sneak peek into the investing activities of the business. Usually, the assets are fixed. Some examples include patents, land and buildings, plants and equipment, trademarks, and long-term investments in securities. However, non-current assets are not always an excellent representation of a company’s financial position and investing activities. This is because some companies overpay to acquire some fixed assets.
Long-term assets represent a company’s ability to keep operations running for the longer term. The company generates long-term liabilities in the process of creating and implementing long-term strategies. These long-term liabilities are what constitute non-current liabilities. The balance sheet captures these kinds of liabilities to help analysts form an accurate picture of a company’s finances for a period of 12 months or more in the future. Current liabilities capture the obligations of a company that lie within the reporting period.
Non-current liabilities help analysts come up with various ratios that enable you to assess a company’s leverage. The debt-to-capital ratio is one example, and is crucial for determining a company’s leverage. Examples of non-current liabilities include long-term borrowings, secured and unsecured loans, long-term lease obligations, deferred tax liabilities, and derivative liabilities.
As a component of the balance sheet, equity (better known as shareholder’s equity) is often the source of the assets under a company’s ownership. Equity is that share of the company that remains after taking away all the liabilities from the company’s assets — what’s left over after a company liquidates and pays off all debts. The value of shareholder equity is either positive or negative. Positive shareholder equity implies that a company’s assets are sufficient to cover both current and non-current liabilities.