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Understanding the Balance Sheet

The following guideline is general in nature and may not include all situations that a business will need to consider. It is strongly advised that business owners work with a qualified accountant in determining the structure of business financial statements and appropriate methods for accounting that meet the needs of the business and remain compliant with Canada Revenue Agency (CRA) requirements.

A Balance Sheet, also known as a “statement of financial position”, reveals a company’s assets, liabilities and shareholders’ equity (net worth). A Balance Sheet reveals to a business owner, or a potential lender, the overall financial ‘health’ of the business from an equity standpoint. General Definitions: 1. Assets are what a company owns and uses to operate its business. 2. Liabilities are what a company owes on purchase of assets or in financing its operations. 3. Shareholders' equity is the amount of money initially invested into the company plus any retained earnings (net income). The Balance Sheet is divided into two main sections (Assets and Liabilities) that, based on the following equation, must equal (or balance) each other. The main formula behind the Balance Sheet is: Assets = Liabilities + Shareholders’ Equity It is important to note that a Balance Sheet is a snapshot of the company’s financial position at a single point in time. An example of a Balance Sheet is attached on Page 4. It may be useful to view this while reading. Details: 1. Assets Assets are what a company owns and uses to operate its business. There are two classes of assets, Current assets and Fixed or Capital assets, as defined below. a) Current Assets Current Assets are assets that a company has at its disposal (liquid) and that can be easily converted into cash within one operating cycle. An operating cycle is the time that it takes to sell a product or service and collect cash from the sale, i.e.: 30-60 days. Such assets classes are: i. Cash & Equivalents are monies in business accounts. This is usually cash however cash equivalents could also be stock investments, etc. Cash and equivalents are completely liquid assets. ii. Short-Term Investments normally come into play when a company has enough cash on hand that it can afford, and chooses, to invest this money in order to earn interest. Short term investments are those that come due, or can be converted to cash without penalty within one year. This investment cannot be immediately turned to cash without planning but it will earn a higher return than cash in a business bank account. iii. Accounts Receivable consists of the short-term obligations owed to the company by its clients. Companies may sell products or a service to clients on credit, which is tracked in this line until the client pays their invoice in full. iv. Inventories may represent raw materials in stock, work-in-progress goods and finished goods for resale. Not all companies have inventories, particularly if they are consulting or service based companies. v. Prepaid Expenses are expenditures that the company has already paid to its suppliers or service providers for future costs such as insurance, rent, etc. Although this is not liquid in the sense that, if cash was needed, a “refund” may not be possible, it is an asset in the sense that it preserves cash for future use.

Basin Business Advisors Program Business Guidelines: Understanding the Balance Sheet Page 1

until the asset is fully depreciated. expected to be turned to into cash within a year and/or have a life span of over a year. while Amortization is the corresponding calculation for intangible assets. Basin Business Advisors Program Business Guidelines: Understanding the Balance Sheet Page 2 . Accounts Payable are financial obligations the company owes for services or goods purchased. It is not expensed at the time of purchase but rather depreciated at an assigned percentage. A business should seek the advice of an accountant to determine what assets should be assigned as Fixed/Capital assets if there is any doubt. Long terms debts may include: i. Shareholder loans. Deposits on unfulfilled contracts. v. When a sole proprietorship generates a positive Net profit this profit is reported as personal income in the year it is incurred. relevant for building contractors. When a company generates a profit. Liabilities: Liabilities are what a company owes on purchase of assets or in financing its operations. Mortgage financing iii. Note: Depreciation or Amortization calculations will appear in this section of the Balance Sheet. a) Current Liabilities Current liabilities are the financial obligations a company owes to outside parties that are due within one year or could be called in for repayment by the lender at any time and include: i. Accrued Liabilities: tax remittances (ie: GST) and payroll benefits. There are two classes of liabilities: Current liabilities and Long Term liabilities as defined below. patents and copyrights. 2. Secured Bank loans with terms of repayment over one year ii. 3. The value of Depreciation/Amortization is booked in as an expense in the companies’ Income Statement. equipment. Corporations can manage their tax implications through payment of these dividends and retained losses. e. a company vehicle is considered an asset of the business. buildings and land. or retain the earnings to reinvest into the business.b) Fixed or Capital Assets Fixed/Capital Assets are those that are not turned into cash or liquidated easily. Shareholders’ Equity Shareholders’ equity is the initial amount of money invested into a business plus any subsequent investments less cash withdrawn and plus or minus Net profit. In order for the Balance Sheet to “balance”. iii. Depreciation is calculated and deducted from tangible assets.g. Tangible assets such as machinery. Both calculations represent the economic cost of fixed assets over their useful life. which are due after a period of at least one year from the date of the balance sheet. b) Long Term Liabilities Long-term liabilities are debts. An accountant is required to guide the business in managing this aspect of the business effectively. management will either pay shareholders a cash dividend. As an example. Short-term loans: Lines of Credit and Credit card balances ii. Examples would be: i. Total assets must equal Total liabilities plus Shareholders’ equity. vacation pay and bonuses that the company currently owes. Intangible assets such as goodwill. money owed to employees as salary. whether they have an active agreement for repayment or not. ii. iv. Current portion of long-term debt is the total amount of long-term debt that must be repaid within a year.

31 Assets Current Assets Cash & Cash Equivalents Accounts Receivable Inventory Pre Paid Expenses Total Current Assets Fixed Assets Land Buildings and Improvements Fixtures & Equipment Vehicle . is an important tool for business owners to gain insight into their company and its operations.000 350 37.000 10.350 10. It is important that all business owners know how to use.000 2.Below is an example of a Balance Sheet. analyze and read their Balance sheet.850 5.850 25.500 30.000 140.000 3.000 65.000 103. in tracking financial performance trends and illustrating its ability to take on more credit or risk. The Balance Sheet is a snapshot at a single point in time of the company’s account balances and financial “health”. The Balance Sheet is useful in business analysis. Conclusion The Balance Sheet.000 26.000 44.400 18.350 140.000 20.truck Less: Accumulated Depreciation Total Fixed Assets Total Assets Liabilities & Shareholders’ Equity Current Liabilities Accounts Payable Accrued Liabilities Current Portion of Long Term Debt Total Current Liabilities Long Term Liabilities Long term debt Shareholders’ Equity Shareholders’ Loan Less: Net drawings during the period Retained Earnings Total Shareholders’ Equity Total Liability & Shareholders’ Equity 200X 5.000 20.000 74.100 3. Company Balance Sheet as at Dec.500 40. Owners’ Equity may appear rather than Shareholders’ Equity. Basin Business Advisors Program Business Guidelines: Understanding the Balance Sheet Page 3 .850 Note: The “Equity” portion of a balance sheet may appear differently on some financial statements. along with the Income and Cash flow statements.