About this lesson
The Balance Sheet is the financial report that shows what the business is worth at some instant in time. This lesson will focus on the Liabilities and Equity side of the Balance Sheet.
Balance Sheet Part 3
The Balance Sheet is the financial report that shows what the business is worth at some instant in time. This module will focus on the Liabilities and Equity side of the Balance Sheet.
When to Use Balance Sheets
The Balance Sheet is normally calculated whenever financial reports are prepared and submitted to investors or senior management. It is useful for tracking liquidity and debt.
- Unlike the other major financial reports, the Balance Sheet is for an instant in time, not a period of time.
- The Balance Sheet shows what the company has as assets and what the company owes as liabilities – the difference is the owner’s equity or the net worth of the company.
- The Balance Sheet indicates what types of liabilities a company has – debt, unpaid bills, etc.
- The typical categories of liabilities are listed, some company’s will further subdivide these categories:
- Accounts Payable – this is the money owed to suppliers. When using the accrual basis, an invoice is received for goods and services. Until the invoice is paid, the amount of the invoice is in the Accounts Payable. It is often referred to as a current liability because it is assumed that the bill will soon be paid.
- Short-term Debt – this is debt that must be paid within less than one year from the time the debt was negotiated. It is typically used for lines of credit, credit card debt, or short term “bridge” loans. It is also referred to as a current liability.
- Long-term Debt – this is debt that must be paid over a time period that exceeds one year from the time the debt was negotiated. It is usually used for mortgages and company-issued bonds.
- An unusual category of liability that is sometimes shown is Progress Collections. In some businesses, customers pay for a product up-front, before it has been manufactured or delivered. These payments are shown as a liability until the product is sold, since if the company does not deliver the product, they are normally obligated to return the payment. The Progress Collection account keeps the Balance Sheet balanced. When the down payment was received, the Cash value on the Asset side of the Balance Sheet went up, but inventory did not go down delivering a product. Therefore something on the Liabilities and Equity side had to go up also and the Progress Collections account is what is used to identify that money.
- The value on the Balance Sheet of Equity is the value of the company – at least on paper – and is sometimes called book value. This value can be determined by taking the value of the Assets and subtracting the Liabilities.
- The market value of a company is often quite different from the Balance Sheet Equity because the market will assign value to expected future sales, profits, or opportunities, whereas the Balance Sheet only includes what has already happened in the past.
- There are two categories of Equity, but these are normally divided into further subcategories:
- Owner’s Investment – this is the value of the money provided to the company by the original investors and the value of the money received from any stock offerings. It is not the current value of the stock – which fluctuates daily.
- Retained Earnings – When a company makes a positive Net Income, it often provides a portion of that Net Income to the owners as dividends, but it retains a portion of that income to reinvest into the company. This account is meant to represent that reinvestment. When a company loses money, or distributes dividends that are greater than the Net Income, the Retained Earnings are lowered.
Hints and Tips
- The value used for each category is normally pulled from the accounts in the company’s financial system.
- Many companies will subdivide some of the Balance Sheet accounts to show specific categories of liabilities or equity.
- For example: payables may be divided into payables to suppliers, payables for taxes, and payables of dividends for shareholders.
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