What is a balance sheet?
The Balance Sheet is a statement of what you have (in the business) and where the funding came from. It adds together all the assets in the business (“what you have”), and adds together all the debt and equity in the business (“where the funding came from”); and the two totals balance.
Unlike the income statement, which is a history book showing the business over time, the balance sheet is for a specific moment. Typically, this snapshot is taken at the end of the operating period of the income statement.
So if you did an income statement for a whole year, you’d look at the balance sheet on the very last day of the year. You can do the same for months, quarters, or any individual period you wish to assess.
To put it in everyday terms, the income statement shows your income for the month and how you spent it (e.g., on mortgage, average auto loan on car, food, entertainment) but it does not tell you the value of what you own (i.e. assets) or how you funded the purchase of the assets. The balance sheet will show you the value of your house and car and the value of what’s in your bank account, and whether or not you owe money to the bank… but it does not tell you how much money you received that month, or what you did with it.
The balance sheet shows you the value of what you have (your assets); and it will show you what part of that value you already own yourself (your equity position) and the part that has been funded by bank borrowings and credit cards (your liabilities).
Let’s take a closer look at the elements of a balance sheet.
How to Calculate a Balance Sheet
The assets side of the balance sheet totals up everything you own in the business and groups them by the kinds of assets they are.
Current assets are cash and the things you’re trying to turn into cash, such as your inventory for sale, the items you’re manufacturing, and your stockpiles of raw materials. This category also includes money that your customers owe you but haven’t paid yet.
(For your personal balance sheet the current assets would include cash, bank deposits, and stocks.)
Fixed assets are things you’re not intending to sell or are holding for longer than a year. They include tangible items like land, buildings, machinery, and vehicles, and intangible assets such as intellectual property and goodwill. Most fixed assets depreciate over time.
(For your personal balance sheet the fixed assets would include houses, cars, furniture, and jewelry.)
So on the asset side of the balance sheet, you total up your current and fixed assets.
The other side of the balance sheet identifies where all the funding came from to give you those assets. The funding essentially comes from one of four areas:
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- Money that you or your shareholders invested in the business
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- Additional profits that the company has made since you started running the business (even if it was 100 years ago)
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- Interest-bearing debt, such as money you’ve borrowed from the bank or bonds that you’ve issued
- Non-interest-bearing debt, such as money that you haven’t yet paid to your suppliers for something you bought
The first two are the main sources of equity; this is how they are normally portrayed on the balance sheet.
Liabilities are separated into interest-bearing (e.g. bank loans) and non-interest bearing (e.g. supplier payables). They are also separated by when they fall due: short-term liabilities are the debts you must pay off in the current year; long-term liabilities are due further out.
If you add the value of your equity items and liabilities together, that total will be the same as the total of all the assets you have. Assets are “what you have”. Liabilities and equity show “where the funding for the assets came from”. The two totals will balance, which is why it’s called a balance sheet.
(For your personal balance sheet the short-term liabilities would include credit card debt and utility bills; long-term debt would include a household mortgage. Your equity position is the difference between total assets and total liabilities.)
Balance sheets in the office
You’ve probably heard the term “balance sheet” used in your office. It’s commonly referred to in statements such as, “Our balance sheet isn’t very strong.”
What the speaker means is that your company is carrying a lot of debt, more than they’re comfortable with given the amount of equity you have in the business.
Your equity, again, is the end total you’d receive if everything was sold off at book value, if the banks and other creditors were paid first and you had only what was left over. So if there are a lot more liabilities than equity, it means the bulk of the business is actually owned by other people rather than owned by you.
A strong balance sheet, then, does not have a lot of debt. The debt that it does have isn’t coming in too soon, and there is plenty of cash coming in from customers to keep the operation running without you having to go to the bank for more money.
Here is an example of a strong balance sheet: that of Apple.
And here is a weak balance sheet: that of General Motors in 2007, shortly before it failed in 2008.
Even if you hid the names of the companies, you can use Visual Finance to guess which balance sheet belonged to which company simply based on a general impression of the colors.
Conclusion
The images above are examples of Income|Outcome’s Company Board tool. It is an example of visual finance, which is very simply an interactive way to gain financial understanding.
Balance sheets are an essential part of a company’s reporting, and visual finance is the most effective way to understand a balance sheet’s components. It’s easy to understand connections between current and fixed assets, and where they are funded from, when they are displayed as stacks of color that can be compared against each other.
[Tweet “Once you know the values on a balance sheet, you’re able to use it for the good of the company.”]
For a scannable chart of what makes up a balance sheet, click here.
Or, for a visual examination of Google’s 2012 balance sheet, check out this article.