Understanding Balance Sheets

The Balance Sheet presents information about a company's assets, liabilities, and equity on a certain date. Balance Sheets normally subdivide assets and liabilities into current and non-current categories. The typical reporting period for a Balance Sheet is either the end of a quarter or the end of a fiscal year. A fiscal year is any 12-month period.

Assets are everything of value that a business owns or controls. A tangible asset has physical form, such as inventory, buildings, and equipment.  Assets can be intangible.  Examples of intangible assets include the value of a patent or a trademark, a copyright, and goodwill.  Goodwill is often one of the largest intangible assets.  Generally, when a company lists Goodwill as an asset, that reporting company has purchased another company, but at a price higher than the book value of the assets.  In this situation, the overage is recorded as Goodwill.

Fixed assets are assets used in the operation of a business.  Fixed assets are not expected to be sold in the ordinary course of business.

Liabilities are debts owed by the company to organizations or to individuals. An example of a liability would be a company's accounts payable debt. Current liabilities are those due within one year of the date of the Balance Sheet. Long-term liabilities are due in more than one year.

Equity [sometimes called net worth, stockholder's equity or shareholder's equity] equals Total Assets minus Total Liabilities.  Equity is the obligation of the corporation to its owners after all other creditors have been paid.  A Balance Sheet must balance. Assets equal total liabilities plus equity, and therefore equity equals assets minus liabilities.

Equity can be either positive or negative. When the value of assets exceeds liabilities, equity is positive. When the value of liabilities exceed assets, equity is negative. Most companies have a positive net worth, and creditors are concerned about how much equity the company has in relation to its total liabilities. A company in which liabilities exceed assets has a deficit net worth. From the perspective of an unsecured creditor, any customer reporting a deficit net worth represents an unusually high risk of either late payment or nonpayment.

It should be noted that the values appearing on a customer's balance sheet typically do not correspond to their actual market value.  Rather than guessing at the value of assets, the Conservatism Principle dictates that companies cannot mark up the value of most assets. 

© 2011.  Michael C. Dennis.  All Rights Reserved.  Michael is the author of "Credit and Collection Handbook." E-mail questions or comments to him at mcdennis13@yahoo.com