At face value, reading a balance sheet is simple: assets are categorized and totaled, and liabilities are categorized and totaled. Subtract the latter from the former. If the balance is positive, the company survives. Understanding what a balance sheet conveys requires more than basic math, and the two major categories should always equal each other.
Categories of Assets
The two main sections of a balance sheet are labeled “Assets” and “Liabilities and Owners’ Equity.” But within each, subcategories and differences exist. Two types of assets compose equity, also known as shareholders’ equity. A proper balance sheet has equal amounts totaled for equity and liabilities.
“Current” assets encompass either cash or assets that can be or are expected to be liquidated within one year-easily and within the short term. Assets are primarily objects that have monetary value. Current asset entries might include Accounts Receivables, Cash and Equivalent, Inventory, among others. However, an asset can be intangible, as well, such as brand recognition or a company’s reputation with the public. Only tangible or “hard” assets are listed on a balance sheet.
“Non-Current” assets generally have duration or viable use life longer than one year or that cannot be liquidated easily or quickly. Examples include buildings and other permanent structures such as parking garages. Intangible, non-current assets can include those mentioned above: brand recognition or public faith, as well as material copyrights or active patents.
Because of the differing natures of the two types of assets, each type is listed and subtotaled separately on a balance sheet, though both on the Assets part of the document with each subtotal included in the Total Assets figure.
Liabilities and Owners’ Equity
As in the asset category, two basic types of sub-liabilities exist, and the same general criteria apply: short-term and long-term liabilities. Each subsection is totaled independently of the next section listed on the balance sheet.
“Current” or short-term liabilities include such listings as Accounts Payable, Accrued Expenses or Liabilities, Income Taxes (commonly shown as Accrued Income Taxes), and Capital lease fees (payable in under a year).
The non-current section commonly includes such entries as Long-Term Debt (loans, liens, etc.), Obligations under Capital Leases (beyond a one-year time frame), Deferred Income (and business) Taxes, and similar items.
Owners’ Equity or Shareholders’ Equity is always an independent section in the Liabilities column, because dividends are paid externally, just as a vendor’s invoice is paid “out of house.” Included in this section are the preferred and common stock values, Retained Earnings, and Capital in Excess of Par Value (or paid-in capital), Accumulated Other Comprehensive Income (income not yet realized, such as Treasury bills or stocks and bonds, and pension funds).
Each Assets subsection is totaled and carried into the Assets Total at the bottom of the page. Each Liabilities section is also totaled and carried into the columns total.
When properly annotated in the sections, the Assets Total and the Liabilities and Owners’ Equity Total should equal each other. The total a business “has” equals the total a business “owes.”
Wiley Publishing, Inc., “Reading Financial Reports for Dummies,” ©2009; by Lipa Epstein.
McGraw Hill, “Analysis of Financial Statements” ©2000; by Leopold Bernstein and John Wild.
The Career Press, “Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports,”©2009, by Thomas R. Ittelson.