What is a balance sheet? – Produce a blue book

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This is a four-part online series on financial statement basics adapted from an article on credit and finance in the July-August 2022 issue of Produce Blueprints. To read the full issue online, click here.

Four documents – the balance sheet, the income statement (or profit and loss account), the statement of cash flows and the statement of shareholders’ equity – constitute what the financial world calls “financial statements”.

Each is closely related to the others and necessary to fully analyze the financial situation of a company.

The balance sheet shows the financial situation of a company on a specific date. It includes assets, liabilities and equity.

Assets are resources owned by a company, while shares are rights or claims to said resources. If a business has $100,000 in assets, it also has $100,000 in claims on those assets. The relationship, written as an equation, is assets = actions.

Shares can be subdivided into claims of creditors or claims of owners. Claims of creditors are called liabilities, while claims of owners are called equity. The equation just shown can then be extended to assets = liabilities + equity.

This is called the “basic accounting equation”. The assets must be equal to the sum of the liabilities and the owner’s equity. Table 1 reflects the basic format of a balance sheet illustrating the general flow of this equation.

Assets
The assets part of the balance sheet can generally be broken down into three parts: current assets, fixed assets and other assets, as seen in Table 1.

Current assets are cash and other resources that can reasonably be expected to be realized in cash, sold, or consumed in the business within one year of the balance sheet date or operating cycle of the society.

Other current assets may include, but are not limited to, accounts receivable, inventory, marketable securities and prepaid expenses.

Current assets are a company’s most liquid assets (liquidity refers to the ease with which these assets can be converted into cash) and are very important to a company’s ability to manage its obligations and liabilities. expenses.

Fixed assets are tangible resources that are relatively permanent in nature, used in the business and not intended to be sold. These can be land, buildings, machinery, equipment, furniture and facilities. These assets are considered less liquid and used to operate the business.

Other assets are often referred to as intangible assets and may include goodwill, patents and/or trademarks. They may also include various notes receivable from corporate officers or employees, or insurance surrender values. These too are less liquid.

Passives
Current liabilities are the counterpart of current assets. These are obligations that can reasonably be expected to be paid out of existing current assets or other current liabilities within one year.

Current liabilities may include accounts payable, use of line of credit, wages and salaries, taxes and current maturities of long-term debt.

The relationship between current assets and current liabilities is important when assessing a company’s liquidity or its ability to pay obligations that are due within a year.

When current assets exceed current liabilities, the probability of paying current liabilities is favourable; when the reverse is true, liquidity can be an issue.

Long-term liabilities are obligations that are expected to be paid after one year. These liabilities are often a mortgage or vehicle note, or other debt associated with bank financing.

Equity
Owner’s equity is the owner’s claim on the business and is equal to total assets minus total liabilities. It is the value remaining after all liabilities have been subtracted from all assets.

Owner’s equity is essentially ownership investment and increases on business profitability or additional contributed capital, and decreases on losses or capital drawdowns. A positive owner’s equity number, derived from earnings, is most desirable.

Revenues, expenses, and profitability are all relevant to equity performance and the key elements of the income statement, which will be covered in part two of this article series.

Liquidity
Managing a business for financial health means being able to see the big picture through the details of a business’s financial statements, or in this case, the company’s balance sheet.

It is important to know the degree of liquidity or indebtedness of a company, on the date indicated. Leverage refers to the amount of borrowed capital used by a company to grow its asset base.

A company’s balance sheet position will show its ability to pay short-term obligations on time, assess and evaluate financing options, and meet unforeseen expenses.

Table 2 presents a comparative balance sheet for two years ending December 31 for 2020 and 2021. We will refer to this table as we progress in our analysis.

*Note that for each period, the basic accounting equation is balanced: total assets as of December 31, 2021 were $350,000, while total liabilities ($200,000) and equity ($150,000) totaled $350,000. The same is true for 2020.

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