Cooperate Balance Sheet
The balance sheet is like a snapshot in time of how a company is doing. There is actually a reason why a balance sheet says “as of XX/XX/XXXX” instead of for the period of. The balance sheet is the account values on a particular day instead of over a time frame. The way this was explained to me is to think of this like a picture or snapshot instead of a movie. This is one of the most analysed and important statements for any investor because it shows the overall health of the company’s finical situation. In the finance world, you might hear, “The company has a clean balance sheet” which is another way of saying that the company is in a great financial position.
One of the important things you can see on the balance sheet is the amount of outstanding debt, how many liabilities the company has and how much of the company is owned by equity (classes of stock) This statement is like doing a credit check before you make an investment in the company because you can learn how risky a company is based on balance sheet data and financial ratios.
The Balance Sheet Equation:
Assets = liabilities + Stockholder equity
Understanding the Basic Equation
The simplest way to understand this basic accounting equation is not to think of it like an accountant would. The words debit and credit simply mean left and right. I think of it like an algebra equation that always has to be equal. If you add or subtract from one side, you must do that same thing to the other side.
Classified Balance Sheet
The above equation is an oversimplified version of the way public companies present their balance statements. Public companies report their financial statements in classifications by grouping assets and liabilities into booth long term and short term classifications.
There are benefits as the user to receiving the information this way instead of everything grouped together. This gives the users a better understanding of the short-term and long-term position of the company. It makes a difference if debt needs to be paid off within one year (long-term) vs short-term debt (needing to be paid back within the next year.)
Another thing that is important to financial users is financial ratios. These would be difficult or almost impossible to calculate without the classification system on the balance sheet. These ratios help booth individual investors and institutional investors learn about the companies financial position and even compare them to their peers.
By definition, a current asset is something a business will use within the next year. This is the most liquid form of assets on the balance sheet meaning that the business has easier access to them vs property, plant, and equipment or fixed assets. There are a few common things that you will see in the current asset section of a balance sheet but a good example is cash and equivalents because at almost any time the company has access to this resource to use.
Property, Plant, and Equipment
Accountants normally have long names for things. This is often referred to as PPE to shorten the title. Things under this classification are normally held for longer than a year and that is why they are in their own section. If you compare PPE to personal finance it would be the items you own over the long term such as your vehicle, home, or items inside your home.
For a business; however, these are things like property that the company owns or factories used in producing goods. This could also be company vehicles. Unlike current assets, these have long term value and have less liquidity (they take a longer time to sell)
Depreciation and Appreciation
Depreciation is when an asset loses value over a period of time. This is shown on the balance sheet after the long-term assets. With GAAP accounting, this number has little to do with the actual value the business could sell the item for or Fair Market Value. Instead, it is the:
Purchase price – Depreciation = The Book Value
This is important to understand because no real transaction takes place until the item is sold then the business can claim a gain or loss. Like your personal vehicle aging and wearing out, the same is true about business equipment. It can only be used for a limited amount of time and depreciation is a way for accountants to show this through depreciation on the balance sheet.
Appreciation is something important for investors to understand. There is a common investment called Real Estate Investment Trusts (REIT’s). These are pools of real estate managed by professionals and you get to take part in being a landlord on these properties. This is one of the times that using depreciation doesn’t make sense because the value of properties normally goes up instead of down. There are special ways to analyze these that falls outside of the scope of the accounting section on this website right now.
Current liabilities is any debt that needs to be paid within the next year. Some of this debt could have been short term in nature such as a credit card. Other times this can be long term debt that is coming due within the next year.
Long Term Liabilities
Long-term debt has two important components to it when you analyze it as an investor. First is the amounts that are going to be reclassified into current debt and the amount of interest this is costing the company that is holding it. This should give the financial statement user a better idea of the chance that a company might default.
These are general rules for this classification. There are real world examples of business that have to overstate their current liabilities such as sensors palace who was in the middle of a refinancing deal when their financial statements were reported. It is important to investigate things along these lines because they did get most of their current debt reclassified as long term.
The owners equity represents how much is left over for the equity owners of the company. The equity portion is important for investors who purchase stock because this is technically their claim to the business.