In financial accounting; a world of numbers, columns, headings, and alphabet soup, sometimes even the most basic financial statements deserve a second look to fully grasp their purpose. In this case we will breakdown the make up of a balance sheet. A balance sheet prepared by a small company will be the same in purpose as that of a massive corporation Microsoft like. A balance sheet provides quick look at a business' financial situation. Remember: Balance sheets provide a look at the financial situation at a POINT IN TIME. A business will typically review its balance sheet at set intervals ie monthly or quarterly.
Anyone learning accounting will, no doubt, remember this equation:
Assets = Liabilities + Owner's Equity. (Note: Assets are increased by DEBITS while Liabilities and Owner's Equity are both increased by credits.) This equation IS the balance sheet, without all of the specific accounts, of course.
The Assets portion of the balance sheet can be divided in to two categories. Current assets are assets that typically have a useful life of less than one year. Assets are listed in order of how fast they can be converted in to cold hard cash, or how liquid they are. Current assets are more liquid than their long term counterparts. For instance, under the current assets heading you will most likely find items such as cash, accounts receivable, and inventory. In addition to currents assets, you will find a 'Long Term Assets' heading. Long term assets are items that a company will be in possession of for more than 1 year. Property, plants, and equipment are fine examples of a long term assets. A company probably will not move from plant to plant every year, therefore this would be considered a long term asset. You may also find long term investments and goodwill under long term assets.
Liabilities can be thought of as what a company or corporation owes. Loans, bonds issued, and accounts payable are considered liabilities. They, like assets are listed by how quickly they need to be repaid. Liabilities are similar to assets in that they can be current or long term. Current assets can include, but are not limited to, short term loans and accounts payable.
Owner's equity Owner's equity represents the amount of ownership shareholders have in the particular company plus or minus the company's earnings or losses. So when you buy stock in a particular company you add to the amount of owner's equity represented on the balance sheet. Typically under the owner's equity heading you will find preferred stock, common stock and retained earnings.
Preferred stock can be thought of as a higher class of stock. Those owning preferred stock in a company will feel less fallout if the company goes bankrupt, than will those owning common stock.
Retained earnings are the earnings that are to be kept within the company. When a company makes money it may distribute some of that to its shareholders as dividends or it will keep the money and place it under the retained earnings heading. Retained earnings will be subtracted from a company's Owner's Equity.
A balance sheet will typically be formatted as a vertical form of the equation that we learned in the first paragraph. First the assets will be listed at the top of the statement with the individual accounts being listed in order of liquidity, or how quickly that can be converted in to cash. So, cash or cash equivalents would be listed first. The total of all assets, current and long term, is annotated under the individual accounts for that specific reporting period.
Next, the liabilities are listed in the same fashion as the assets. The liabilities with the nearest due dates are listed first. So, accounts payable will be listed at the top of the liabilities section, directly under the heading. Once again, under the individual liability accounts, the total will be in bold.
Lastly, the Owner's Equity accounts are listed. The owner's equity stock accounts are listed in order of class. Being that preferred stock is a higher class of stock, it will be listed above common stock. Under the 'stocks' you will find retained earnings. In accounting when a number is subtracted, it is annotated as such by being placed in parentheses. Therefore, being that retained earnings are subtracted from owner's equity, its total will be placed in parentheses. Thus, as a total, you will find the total of all of the owner's equity minus the total retained earnings.
Now that all three portions of the equation have been accounted for, and the corresponding totals have been found, you must check that the balance sheet, IS in fact balanced (there's a reason its called a BALANCE sheet.) Going back to the fundamental equation in the first paragraph, check to make sure that when you add the totals of Liabilities and Owner's Equity, you end up with exactly the same total as that of the Assets accounts.
Please remember that a small company's balance sheet will not have the same number of a accounts that a huge corporation's does. However the format will remain constant, no matter the number of specific accounts that are listed. Finally … Assets = Liabilities + Owner's Equity.