The Accounting Balance Sheet
How much are you worth?
The accounting Balance Sheet is one of the main financial statements of a business. The other financial statements are the Income Statement and Cash Flow Statement. The worth of an entity is reported in the balance sheet. The balance sheet is a rearrangement of the accounting equation.
Worth = Assets – LiabilitiesEquation 1a: Accounting Equation
Assets = Liabilities + WorthEquation 1b: Balance Sheet Statement
As shown in equation 1b, the accounting balance sheet must always be in balance. Assets must equal the sum of liabilities and worth. This is why it is called a balance sheet.
As stated before, the net worth (monetary value) of a business or person is determined by reviewing their accounting balance sheet. Let’s review an example below.
Dave the owner of XYZ Manufacturing wants to expand his gas tank business to include automobiles. A major car producer (ABC, LLC) is looking to do business with XYZ Manufacturing. Before ABC, LLC approves XYZ Manufacturing as a possible supplier of gas tanks they want to determine if the company will be around for a while. So ABC, LLC asks for XYZ Manufacturing’s balance sheet to determine their net worth. Balance Sheet of XYZ Manufacturingas of Today's Date
Table 1: Accounting Balance Sheet of XYZ Manufacturing
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|Fixed Assets @ Cost||1,750,000|
|Net Fixed Assets||1,671,427|
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|Current Portion of Debt||100,000|
|Income Taxes Payable||139,804|
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|Total Liabilities & Equity||$3,184,419|
The accounting balance sheet of XYZ Manufacturing in Table 1 shows a balance between the Total Assets and the Total Liabilities & Equity; indicated in Equation 1b. Also notice net worth (Shareholder’s Equity) of $1,881,883.00. Therefore presenting to ABC, LLC that the company is doing well financially and should be around for a while. ABC, LLC approves XYZ Manufacturing as a supplier for their automotive gas tanks.
There are accounting ratios ABC, LLC could use to determine the financial health of XYZ Manufacturing. Before that discussion let’s understand each item on the accounting balance sheet.
Cash: Money in the bank and in petty cash.
Accounts Receivable: An agreement between an entity and customer through an invoice to receive money at a future date for delivery of a product or service.
Inventory: Raw material, work-in-process and finished goods that have not been sold.
Prepaid Expenses: Bills the entity has paid in advanced for services not yet received; such as insurance premiums, prepayment of rent, deposits to utility companies, salary advances, and retainer fees.
Current Assets: Assets that are expected to convert into cash in less than 12 months. It is the sum of Cash, Accounts Receivable, Inventory and Prepaid Expenses.Current Assets = Cash + Accounts Receivable + Inventory + Prepaid Expenses
Other Assets: Intangible assets such as patents, trade marks, copyrights, etc.
Fixed Asset: Property, plant, and equipment (PP&E) used to produce, store and ship the product or service. These items are not attended for sale.
Depreciation: The decline in useful valued of a fixed asset due to normal wear and tear from usage and passage of time. Accumulated depreciation is the sum of all depreciation taken since the asset was purchased.
Net Fixed Assets: The book value of fixed assets. Net Fixed Assets = Fixed Assets @ cost – Accumulated Depreciation
Total Assets: The sum of all assets Total Assets = Current Assets + Other Assets + Net Fixed Assets
Accounts Payable: Bills for material and equipment bought on credit that the entity must pay in less than 12 months.
Accrued Expenses: Bills for items that were not bought on credit; such as salaries, lawyer bills, interest due on loans, etc.
Current Portion of Debt: money due with in 12 months to repay a loan. For example, on a 30-year mortgage, include the sum of the next 12 months of payments from the date of the balance sheet. The remaining months are included in Long-Term Debt.
Income Taxes Payable: Income taxes the entity owes the government that is not yet paid.
Current Liabilities: Bills that are due with in 12 months of the Balance Sheet date.Current Liabilities = Accounts Payable + Accrued Expenses + Current Portion of Debt + Income Taxes Payable
Long-Term Debt: money due in 13 or more months to repay a loan.
Capital Stock: The original money to start and any add-on money invested in the business for shares of ownership in the entity.
Retained Earnings: A company’s profit not returned to shareholders as dividends. Retained earnings have a direct connection with an entity’s net income on the Income Statement.
Shareholder’s Equity: The value of the company to its owners. Also called net worth.Shareholder’s Equity = Capital Stock + Retained Earnings
Total Liabilities & Equity: Total obligation plus worth of the entity.Total Liabilities & Equity = Current Liabilities + Long-Term Debt + Shareholders’ Equity
The absolute numbers on the balance sheet are not enough to truly understand the financial health of an entity. One must evaluate the relationship of the line items on the balance sheet to each other. This is where understanding accounting ratios is extremely important.
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