|Balance Sheet Components
The balance sheet is the financial statement that
reports the assets, liabilities and net worth of a
company at a specific point in time. Assets represent
the total resources of a company, which may shrink or
increase depending on the results of operations.
Assets are listed in liquidity order - ease of converting
into cash. Typical assets include: cash, accounts
receivable, inventory, fixed assets and a number of
miscellaneous assets we have classified as "other
assets". Liabilities include what a company owes:
accounts and notes payable, bank loans, deferred
credits and "miscellaneous other". All businesses
divide assets and liabilities into two groups: current
(convertible to cash within a year) and non-current.
Net worth is the owner's investment (in the case of a
proprietorship or partnership) or capital stock (original
investment) plus earned surplus (earnings retained in
the business) in the case of a corporation.
Current Assets (sometimes referred to as trading
assets) include cash, trade receivable and inventory.
These are items that can be converted to cash in less
than one year or in the normal operating cycle of a
business. Also included in this category are any
assets held that can be readily turned into cash with
little effort, such as government and marketable
Current Assets - Cash
Cash refers to cash on hand on in banks, checking
account balances, and other instruments such as
checks or money orders that have not yet been
deposited. A rule of thumb is that cash positions are
generally strongest after the peak selling season.
When cash balances are continually small, it may be
that a business is experiencing slow receivable
collection or some other financial weakness.
Current Assets - Marketable Securities
Marketable securities are found on many balance
sheets. Marketable securities can include: government
bonds and notes, commercial paper, and/or stock and
bond investments in public corporations. Marketable
securities are usually listed at cost or market price,
whichever is lower. Accountants will frequently list
securities at cost with a footnote indicating market
price on the balance sheet date. (When marketable
securities appear on a statement, it frequently
indicates investment of excess cash.)
Current Assets - Accounts Receivable
Sales between most businesses are made on a credit
basis. Accounts receivable indicate sales made and
billed to customers on credit terms. A retailer, such as
a department store, may show its customer charge
accounts billed and unpaid in this category. In many
businesses, accounts receivable are frequently the
largest item on the balance sheet. You should pay
special attention to this category as the company's
financial health depends upon timely collection of
Every business that has accounts receivable will
probably have some portion that it is unable to collect
because customers fail to pay for one reason or
another - mismanagement, disaster or intent. Usually a
business will set aside an estimated allowance for
these uncollectable or doubtful accounts. This
allowance called "bad debt" is deducted from the total
receivables shown on the balance sheet. Frequently a
footnote identifying the amount deducted will be found
in the statements.
Current Assets - Notes Receivable
Notes receivable represent a variety of obligations with
terms coming due within a year. Notes receivable may
be used by a company to secure payments from
past-due accounts, or for merchandise sold on
installment terms. In any case, notes receivable should
Current Assets - Inventory
You will find that inventory includes different items
depending on whether a business is a manufacturer,
wholesaler or retailer. Retailers and wholesalers will
show goods that are sold "as is" with no further
processing or supplies required before shipping. On
the other hand, many manufacturers will show three
different classes of inventory: raw materials,
work-in-process or progress and finished goods. Raw
materials are considered the most valuable part of
inventory as they could be resold in the event of
liquidation. Work-in-process has the least value
because it would mostly likely require additional labor
before the product is finished and has a value in the
marketplace. Finished goods are ready for resale.
Finished goods values can vary greatly according to
circumstances. If they are popular products in good
condition that can be easily sold, then the value shown
might be justified. If the goods are questionable in
their marketability, the value may be carried too high.
The manufacturer's cost of labor employed in the
production of finished goods and goods in process, as
well as factory expenses is included in the value.
Inventory is normally shown on the balance sheet at
either cost or market value, whichever is lower.
As a company's sales volume increases, larger
inventories are required; however, problems can arise
in financing their purchases unless turnover (number
of time a year goods are bought and sold) is kept in
balance with sales. A sales decline should be
accompanied by a decrease in inventory in order to
maintain a healthy condition. If a business has a
sizable inventory, it may have partially completed or
finished goods that are obsolete, or it could reflect a
change in market conditions.
Current Assets - Other Current
This category includes prepaid insurance, taxes, rent
and interest. Some conservative analysts consider
prepaid items as non-current because they cannot be
converted to cash to pay obligations quickly, and
therefore have no value to creditors. Normally, this
category is not large in relation to other balance sheet
items, but if it is sizable it may require further review.
Non-current assets are items a business cannot easily
turn into cash and are not consumed within
business-cycle activity. We have defined current
assets as those that can be converted into cash within
one year. In the case of non-current assets, they are
defined as assets that have a life exceeding a year.
Non-current Assets - Fixed Assets
Fixed assets are materials, goods, services and land
used in the production of a company's goods.
Examples include: real estate, buildings, plant
equipment, tools, machinery, furniture, fixtures, office
or store equipment and transportation equipment. All
of these would be used in producing products for a
company's customers. Land, equipment or buildings
not used in the production of customer goods would
be listed as other non-current assets or investments.
Fixed assets are carried on the company's accounting
books at the price they cost at the time of purchase.
All fixed assets, except land, are regularly depreciated
since they are expected to eventually wear out.
Depreciation is an accounting practice that reduces
the fixed asset's carrying value on an annual basis.
The reductions are considered a cost of doing
business and are called a depreciation charge.
Eventually the fixed asset will be reduced to its
salvage or scrap value. Normally the accounting
procedure is to list the fixed asset cost less
accumulated depreciation, which would be shown on
the statement or in a footnote. Bear in mind, not all
companies can be comparable on this item as some
rent their equipment and premises. If a business rents,
its fixed asset total will be probably be smaller
compared with other balance sheet items.
Non-current Assets - Other Assets
Under the other assets category, several items can be
lumped together. The following items may be itemized
separately on other balance sheets, and if significant,
should be closely examined: investments, intangible,
and miscellaneous assets.
Investments of a business represent assets of a
permanent nature that will yield benefits a year or
more after the date of the financial statement. These
may include: investments in related companies such
as affiliates (partly owned) and subsidiaries (owned
and controlled); stocks and bonds maturing later than
one year; securities placed in special funds; and fixed
assets not used in production. The value of these
items should be shown at cost.
Miscellaneous assets include advances to and
receivables from subsidiaries, and receivables from
officers and employees.
Intangible assets are those that may have great value
to an operating company but have limited value to
creditors. Analysts tend to discount these items or
value them very conservatively. Intangible assets may
be: a company's goodwill, copyrights and trademarks,
development costs, patents, mailing lists and catalogs,
treasury stock, formulas and processes, organization
costs, and research and development costs.
Current liabilities are obligations that a business must
pay within a year. Generally they are obligations that
are due by a specific date, usually within 30 to 90 days
of fulfillment. To maintain a good reputation and
successful operations, most businesses find they must
have sufficient funds available to pay these obligations
Current Liabilities-Accounts Payable
Accounts payable represents merchandise or material
requirements purchased on credit terms and not paid
for by the balance sheet date. When reviewing
balance sheets of small companies, you will frequently
find that liabilities principally fall into the accounts
payable line. Suppliers expect their invoices to be
paid according to the terms of sale specified. These
can range from net 30 to 90 days (after invoice date)
plus discount incentives of 1 percent or more if
payments are made by a specified earlier time.
Companies able to obtain bank loans frequently show
small accounts payable relative to all of their current
liabilities. The loans are often used to cover material
and merchandising obligations. Large payables shown
in conjunction with other outstanding loans, may
indicate special credit terms being extended by
suppliers or poor timing of purchases.
Current Liabilities - Bank Loans
If a business has borrowed from a bank without
collateral, the bank loan would be considered
unsecured (no collateral pledged) which is a favorable
sign. It shows the business has an alternative credit
source available other than suppliers, and the
business meets the strict requirements of a bank. On
the other hand, if collateral has been pledged, then
the loan would be listed as secured (the bank has a
claim on part or all of the borrower's assets). Loan
nonpayment can result in the bank satisfying its claim
by taking possession of the secured asset and selling
it. Some companies have a line of credit (a limit up to
which it can borrow) as a bank customer, which is also
a sign that it is regarded as a good risk. This line is
used by companies frequently during peak selling
seasons. However, if a company has a line, you would
be wise to find out the amount to determine the bank's
evaluation of the company. Bank loans listed under
current liabilities are to be retired within a year. Bank
borrowing needs generally will increase along with the
Current Liabilities - Notes Payable
A company's borrowings from firms and individuals
other than banks may be included in this category.
This may be for convenience or because bank
financing was not available. Also, a company may
have a credit agreement with suppliers for
merchandise or materials covered by notes payable
that would secure their position.
Current Liabilities - Other Current Liabilities
Several items are lumped together in this category.
Since a business acquires debt by either buying on
credit, borrowing money or incurring expenses, this
line serves as a catch all for the expenses incurred
and unpaid at the time the statement was prepared.
These items must be paid within a year. For example,
wages and salaries due employees for time between
the last pay day and the balance sheet date are
included in this category. Various federal, municipal,
and state taxes (sales, property, social security, and
unemployment) appear under the heading accrued
taxes. Federal and state taxes on income or profits
may also be found here. If a balance sheet does not
show a liability for taxes and a profit is claimed, the
company may be understating its current debt.
Long-term liabilities are items that mature in excess of
one year from the balance sheet date. Maturity dates
(when payment is due) may run up to 20 or more
years. An example of this would be real estate
mortgages. Normally, items in this area are retired in
Long-Term Liabilities - Other Long-Term
The items most often appearing in this category are
mortgage loans, usually secured by the real estate
itself, bonds, or other long term notes payable. Bonds
are a means of borrowing long-term funds for large
and well established companies. When a company is
big enough and financially sound, it will sometimes be
able to borrow money on a long-term unsecured basis.
When this occurs, the unsecured deferred notes are
called debentures. When reviewing unsecured
long-term note payable, you should determine the
holders of the notes. (This information may be found
in the footnotes to the statement prepared by an
accountant.) In smaller companies the owner or
principals of the business will often hold the notes. In a
corporation, the principals can also become creditors
and collect interest. To do this, they simply loan the
corporation money. They would be able to obtain
repayment along with other unsecured creditors in the
event of liquidation. However, at times, other creditors
will require that in event of bankruptcy, officer or
stockholder loans will be paid back last when assets
are distributed. Money invested by stockholders is
rarely recovered if insolvency occurs. It should be
noted that some analysts categorize officer loans as
current liabilities, primarily when repayment schedules
do not exist.
Long-Term Liabilities - Deferred Credits
A deferred credit may indicate that a business has
received prepayment from customers on work yet to
be completed. Since the completed work is still owed
to the customer, the prepayment continues to be
carried as a liability until the product is completed and
delivered, or the prepayment is returned to the
customer. Some businesses will require an advance or
payment for custom work or as a show of good faith.
Net worth represents the owners' share of the assets
of the business. It is the difference between total
assets and total debts. Remember our balance sheet
formula - total assets minus total liabilities equals net
worth (owner's equity). Basically, this is the investment
the owners have at stake in the business. If liquidation
occurs, assets are sold-off to pay creditors and the
owners/stockholders receive what remains. This is why
equity sometimes is referred to as "risk capital."
In proprietorships (owned by an individual) and
partnerships (owned by two or more individuals) the
net worth figure on the balance sheet represents:
Original investment of owners.
Plus... additional investments they have made.
Plus... accumulated or retained profits.
Less... whatever losses have been sustained.
Less... any withdrawals by partners.
On corporate balance sheets, net worth may be
broken down into the following categories:
Capital stock represents all issued or unissued shares
of common or preferred stock. Preferred stock is a
class of stock with a claim on earnings before payment
may be made to common stockholders. Usually
preferred shareholders are entitled to priority over
common stockholders if a company liquidates.
Common stockholders assume greater risk but
normally have greater reward in dividends and capital
Paid-in or capital surplus represents money or other
assets contributed to the business, but for which no
stock or owner's rights have been issued. (i.e. funds
that exceed the stock's par value.)
Earned surplus is the amount of earnings retained in
the corporation and not distributed in dividends.
When a corporation shows a net worth that has as its
components capital stock and retained earnings,
capital stock represents shares of equity issued to
owners. Retained earnings are the amount of
corporate profits permitted to remain in the business
by design of the officers. Analysts view a sizable
amount of retained earnings as significant. It shows a
business is profitable and successful if it recognizes
the need for net worth growth as the company
While the balance sheet gives a very detailed
description of a business, it does not indicate whether
a company is making a profit or losing money. That
information comes from reviewing the income
statement. The net worth reduction can happen in one
of four ways:
1. A loss was sustained
2. Dividends were paid in excess of profits
3. Capital stock was redeemed
4. Assets were written down.
Net worth goes up when:
1. Earnings are retained
2. Capital is added
3. Assets are written up
4. Liabilities are written down
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