Balance Sheet

What does it mean

A balance sheet is a document that lists as of a certain date in time, all of the things owned by the business (Assets), all of the things owed by the business (Liabilities) as well as the difference between the two (Equity).  

Each type of item (Asset or Liability) is organized based on whether or not that item will be either converted into cash (think of inventory being sold for cash) or if the item will be paid with cash (think of money owed on accounts payable to a vendor) in the coming 12 months.  Assets that will typically be converted to cash during normal business in the next 12 months are grouped as Current Assets.  Liabilities that will typically be paid with cash during normal business in the coming 12 months are grouped into Current Liabilities.  Any residual Assets or Liabilities are grouped together as Noncurrent Assets or Noncurrent Liabilities respectively.  Examples of Noncurrent Assets would be Buildings or Equipment, and examples of Noncurrent Liabilities would be a loan that is payable over multiple years.

The difference between the total assets and total liabilities is the equity (or Net Worth) of the business.  

Why does it matter

A balance sheet matters for a variety of reasons:

1. A balance sheet shows how a business has structured itself and its obligations, and this will have a direct impact on their ability to make payments.
2. A balance sheet also identifies potential sources of collateral owned by the business
3. The equity account of the business can show where the net worth of the business derived from.  Did it result from long term profitable operations (Retained Earnings) or did it come from a deep pocketed owner who injected sizable dollars from the outside (Common Stock or Additional Paid in Capital)
4. A balance sheet will show how a business makes and finances investments into its business.  Has it purchased new equipment? Did they pay for that equipment by reducing Working Capital or did they finance it?  
5. Comparing a beginning of the year balance sheet to an end of the year balance sheet will give you a glimpse into the profitability of the business during that time.  Did equity increase?  Did working capital increase?

Other Relevant Terms

• Capital
• Current Assets
• Current Liabilities
• Noncurrent Assets
• Noncurrent Liabilities
• Equity
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