What is…. A Balance Sheet?

Earlier this year, I was asked several questions about different terms or references from an earnings call. Over the course of a couple of articles, I have been addressing some of the more common financial reports or terms that are commonly referred to during these quarterly calls. In previous articles, I have covered the Profit and Loss Statement and cash flow. Today, we are covering the balance sheet. The balance sheet is part of the three core financial statements for any business. The other two are the income statement, and the statement of cash flows.

You tend to hear more about the balance sheet in casual financial conversation as much as on earnings calls. Rightfully so, as it is the accounting of a company’s assets, liabilities, and shareholder equity. All important things. For the investment community, this is what they are using to determine their return for their investment. It is also a view into a company’s capital structure and where they are spending that money.

Assets are a big part of the balance sheet. Assets can be physical things (equipment, inventory etc.), as well as cash or readily available monetary resources (bonds, credit lines). These are offset by the liability (the cost to purchase those things), or the equity that is gained for shareholders for owning them. In other words, as the name suggests, a balance sheet should always balance out.

Assets = Liabilities + Shareholder Equity

As an example, if your business borrows $10,000 from a bank to use for buying equipment, your assets would increase by $10,000 (for the purchased equipment), and your liability is now $10,000 for the loan you owe to pay back. As you pay that debt down, equity grows for the shareholders, while the asset remains the same. If a shareholder invests $5,000 in the business, your cash asset increases by $5,000, while the investor receives $5,000 in equity in the business.

Example Balance Sheet

Example of Balance Sheet (Apple, Inc) from Investopedia

The above example of Apple’s balance sheet provides some additional details on what you would see on a company’s balance sheet. You can see the top and bottom split that clearly shows the assets at the top, and liabilities at the bottom. Cash is listed first, and breaks down into other categories. Things like accounts receivable (what others owe you) is an asset (and it is assumed it will be paid). What you owe (accounts payable) is listed as a liability, since you need to pay that to someone else.

An investor will look at these types of things and then look at cash to see if you are in a position to cover the debt based liabilities that your business has. This is where coupling the balance sheet with the statement of cash flow is useful to understand what this might look like over time. Since the balance sheet  is only a snapshot at that moment, the cash flow will provide a better indicator of what the cash coming in will look like over time. Too much debt and not enough long-term cash is an obvious warning sign.

Shares of stock balance each side out as well. Sold shares of stock raise cash (an asset), but give shareholders equity in the company (something the company owes to the shareholder) to balance out the equation. This is why you frequently hear CEOs and CFOs talking about creating shareholder value. If people stop investing (buying shares) in the company, that reduces the amount of cash coming into the company that can be used for operating or purchasing equipment for the business.

Key Takeaways

- The balance sheet shows assets, liabilities, and shareholder equity.

- Assets are physical and cash related items used or owned for the business.

- The balance sheet provides insight into what a company is spending its money on.

- It can be used to see ratios (i.e., debt to equity) within the business, as well as a return on investment for investors and shareholders.

- The balance sheet is a snapshot in time for these elements. It is not a trend tool, or projection of the future.

This explanation of the balance sheet only scratches the surface, and is meant to provide a quick overview of what a balance sheet is, what it shows, and how it can be used. I would recommend checking out the Investopedia site for a more detailed review of the balance sheet and how it functions within in a business.

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