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What Is A 'Balance Sheet'?

A Balance Sheet is a snapshot of what a business owns and what it owes at a particular moment in time.

Balance Sheets are valuable because they answer many important questions about the financial health of a business. By examining a company’s Balance Sheet, you can determine whether or not the company is solvent, if it’s having trouble paying its bills, and how the company’s value has changed over time.

Josh Kaufman Explains The 'Balance Sheet'

A Balance Sheet is a snapshot of what a business owns and what it owes at a particular moment in time. You can think of it as an estimate of the company’s net worth at the time the Balance Sheet was created.

Balance Sheets always cite a specific day, and use this calculation:

Assets - Liabilities = Owner’s Equity

Assets are things the company owns that have value: products, equipment, stock, etc. Liabilities are obligations the firm hasn’t yet discharged: loans, financing, etc. What’s left over when you discharge all of the business’ liabilities is Owner’s Equity, the company’s “net worth.”

For smaller businesses, the Balance Sheet is pretty straightforward: count your cash on hand, add the estimated market value of any property you own, and subtract all debt and current obligations. Voila: you’ve created a basic Balance Sheet.

For larger businesses, the Balance Sheet is more complicated, and there are more entries to keep track of. Common assets include cash, accounts receivable (credit that you’ve extended to customers), inventory, equipment, and property. Common liabilities include long and short-term debt, accounts payable (credit that other firms have extended to you), and other obligations. Owner’s equity includes the value of the company’s stock, capital from investors, and retained earnings (profit that hasn’t been paid to the company’s shareholders).

What makes the Balance Sheet “balance” is the secondary form of the calculation, which is a rearrangement of the first equation:

Assets = Liabilities + Owner’s Equity

This calculation looks odd at first: why would you ever want to add Liabilities and Owner’s Equity?

Here’s why: when a business borrows money, it receives the amount of cash borrowed. That goes on the Cash Flow Statement, and the influx of money makes it look like the business had a very good month if you don’t notice it’s a loan. When you think about it, the company’s financial picture didn’t really change: the business now has more assets (more cash), but it also has a new liability (more debt). The company’s “net worth” didn’t change at all.

The second formula is useful because it reflects this relationship. Let’s assume you’re starting a business, and you borrow $10,000. Before you borrow the money, your Balance Sheet looks like this:

0 = 0 + 0 (you have no assets, no liabilities, and no equity)

After you borrow the money, your Balance Sheet looks like this:

$10,000 = $10,000 + 0 (you have $10,000 in assets, $10,000 in liabilities, and no equity)

Both sides of the Balance Sheet are the same. The Balance Sheet always balances. If it doesn’t balance, you’ve made an error.

Since Balance Sheets are snapshots of a moment in time, it’s common to review several of them at a time. For example, a company might include Balance Sheets calculated on the last day of its fiscal year for the past two or three years. By comparing the balance sheets, it’s easy to see how assets, liabilities, and owner’s equity have changed over time.

Balance Sheets are valuable because they answer many important questions about the financial health of a business. By examining a company’s Balance Sheet, you can determine whether or not the company is solvent (i.e. its assets are greater than liabilities), if it’s having trouble paying its bills, or how the company’s value has changed over time.

Balance Sheets, just like Income Statements, are full of assumptions and estimates that can introduce bias in the numbers. What’s the value of a brand name or reputation? What percentage of the company’s accounts receivable will be paid? How valuable is the business’ current inventory? Don’t skip the footnotes: by examining the assumptions behind the entries on the Balance Sheet, you’ll develop a more accurate picture of the strength of the business.

Questions About The 'Balance Sheet'

• Do you have a current Balance Sheet?
• If not, can you create one?

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"If you would know the value of money, go try and borrow some."

Benjamin Franklin

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