Balance Sheet Basics Part 1: What Is The Balance Sheet?

A lot of business owners (and even many bookkeepers) really don’t understand the Balance Sheet.  They are mostly concerned with the Profit & Loss report and the only Balance Sheet item they care about is the checking account.  I find this to be a huge mistake on their part!  In my opinion, the Balance Sheet is even more important than the P+L and it’s a real shame that people totally neglect it.

Today’s article is the first in a series titled “Balance Sheet Basics”.  Throughout this series I’m going to state my case as to why the Balance Sheet is important and maybe I’ll be able to convince you that it’s even more important than the P+L!

First off, let me define exactly what the Balance Sheet is.  It is a financial report that presents all of a company’s assets, liabilities and equity accounts as of a certain date.  It is often referred to as a “snapshot” of the company’s financial position since it does only provide the balances as of one particular point in time (unlike the Profit + Loss report which covers activity for a range of dates).

There are three main sections of any Balance Sheet, Assets, Liabilities, and Equity.  The total of the asset section minus the total of the liabilities equals the total of the Equity section (that’s the “balance” part of “Balance Sheet”).  Just to repeat that one more time:

ASSETS – LIABILITIES = EQUITY

This equation is one of the fundamental concepts that you must know in order to work in accounting.  It should just be second nature to you to understand how this works.  Even though most of your work will be on the computer and it will take care of the balancing for you, it will help you immensely if you know and understand this concept.

To put it in a simple example, let’s say that ABC Company owns a building that cost $700,000 and that is the only asset that it has on the books.  It also has a mortgage with a balance of $250,000 at the end of the year.  We are ignoring a lot of other details for this example, but for the sake of this lesson, let’s assume that there are no other account balances at all.  Using the accounting equation we can calculate that ABC Company has equity of $450,000.

$700,000 – $250,000 = $450,000

Each main section of the Balance Sheet is further divided into “sub-sections”.  Some of the most commonly used ones are listed below.  I will cover each of these in more detail in the future since they all deserve their own write up.

Assets

• Current Assets:  Assets that are expected to be sold or used up within the next 12 months such as cash, inventory and accounts receivable
• Fixed Assets:  Tangible assets that are expected to last for more than one year such as equipment, land and furniture
• Intangible Assets:  Non-monetary assets that cannot be physically touched such as patents, copyrights and trademarks

Liabilities

• Current Liabilities:  Debts and obligations expected to be paid off within the next 12 months such as accounts payable
• Long-Term Liabilities:  Debts and obligations not expected to be paid off within the next year such as a 30-year mortgage

Equity

• The Equity section doesn’t really have any “sub-sections”.  It just has accounts like Common Stock and Retained Earnings

Within each of these sub-sections are the individual account balances.  For example the Current Liabilities section might contain three line items: Accounts Payable, Accrued Payroll and Sales Tax Payable.  Some of the accounts presented on the Balance Sheet may represent several accounts on the company’s Trial Balance.  For example, the Company might have 3 accounts on the Trial Balance for various accrued expenses such as Accrued Payroll, Accrued Payroll Taxes and Retirement Plan Contribution Payable.  These three individual accounts balances may be grouped together into one single line item on the Balance Sheet called “Accrued Expenses”.  This makes for a cleaner, more compact presentation and is acceptable as long as the groupings make logical sense.

The Equity section of the Balance Sheet contains accounts that deal with ownership of the company and how much capital has been invested.  Some common accounts are:  common stock, preferred stock, treasury stock, additional paid-in capital, shareholder distributions and retained earnings.

Here is a sample Balance Sheet from QuickBooks for you to review (click the image to view a PDF):

I have much, much more to say about the Balance Sheet but this post has already gone on far too long!  If you have any questions or comments, please leave them in the comments section below.

This post was written by Michael Debyah.