11/14/21, 3:54 PM Balance Sheet Definition: Formula & Examples

Balance Sheet
By  JASON FERNANDO  Updated February 04, 2021
Reviewed by  MARGARET JAMES

TABLE OF CONTENTS

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What Is a Balance Sheet?

The term balance sheet refers to a financial statement that reports a company's assets,
liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis
for computing rates of return for investors and evaluating a company's capital structure. In
short, the balance sheet is a financial statement that provides a snapshot of what a company
owns and owes, as well as the amount invested by shareholders. 1  Balance sheets can be
used with other important financial statements to conduct fundamental analysis or calculating
financial ratios.

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KEY TAKEAWAYS
A balance sheet is a financial statement that reports a company's assets, liabilities,
and shareholder equity.
The balance sheet is one of the three core financial statements that are used to
evaluate a business.
It provides a snapshot of a company's finances (what it owns and owes) as of the
date of publication.
The balance sheet adheres to an equation that equates assets with the sum of
liabilities and shareholder equity.
Fundamental analysts use balance sheets to calculate financial ratios.

1:10
An Introduction To The Balance Sheet

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How Balance Sheets Work

The balance sheet provides an overview of the state of a company's finances at a moment in
time. It cannot give a sense of the trends playing out over a longer period on its own. For this
reason, the balance sheet should be compared with those of previous periods. 2

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Investors can get a sense of a company's financial wellbeing by using a number of ratios that
can be derived from a balance sheet, including the debt-to-equity ratio and the acid-test ratio,
along with many others. The income statement and statement of cash flows also provide
valuable context for assessing a company's finances, as do any notes or addenda in an
earnings report that might refer back to the balance sheet. 2

The balance sheet adheres to the following accounting equation, with assets on one side,
and liabilities plus shareholder equity on the other, balance out:

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Assets = Liabilities + Shareholders’ Equity

This formula is intuitive. That's because a company has to pay for all the things it owns
(assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing
shareholder equity). 1

If a company takes out a five-year, $4,000 loan from a bank, its assets (specifically, the cash

account) will increase by $4,000. Its liabilities (specifically, the long-term debt account) will
also increase by $4,000, balancing the two sides of the equation. If the company takes
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$8,000 from investors, its assets will increase by that amount, as will its shareholder equity.
All revenues the company generates in excess of its expenses will go into the shareholder
equity account. These revenues will be balanced on the assets side, appearing as cash,
investments, inventory, or other assets.

 Balance sheets should also be compared with those of other businesses in the
same industry since different industries have unique approaches to financing.

Special Considerations
As noted above, you can find information about assets, liabilities, and shareholder equity on
a company's balance sheet. The assets should always equal the liabilities and shareholder
equity. This means that the balance sheet should always balance, hence the name. If they
don't balance, there may be some problems, including incorrect or misplaced data, inventory
and/or exchange rate errors, or miscalculations. 2

Each category consists of several smaller accounts that break down the specifics of a
company's finances. These accounts vary widely by industry, and the same terms can have
different implications depending on the nature of the business. But there are a few common
components that investors are likely to come across.

 Theresa Chiechi {Copyright} Investopedia, 2019.

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Components of a Balance Sheet

Assets
Accounts within this segment are listed from top to bottom in order of their liquidity. This is
the ease with which they can be converted into cash. They are divided into current assets,
which can be converted to cash in one year or less; and non-current or long-term assets,
which cannot.

Here is the general order of accounts within current assets:

Cash and cash equivalents are the most liquid assets and can include Treasury bills and
short-term certificates of deposit, as well as hard currency.
Marketable securities are equity and debt securities for which there is a liquid market.
Accounts receivable (AR) refer to money that customers owe the company. This may
include an allowance for doubtful accounts as some customers may not pay what they
owe.
Inventory refers to any goods available for sale, valued at the lower of the cost or market
price.
Prepaid expenses represent the value that has already been paid for, such as insurance,
advertising contracts, or rent.

Long-term assets include the following:

Long-term investments are securities that will not or cannot be liquidated in the next year.
Fixed assets include land, machinery, equipment, buildings, and other durable, generally
capital-intensive assets.
Intangible assets include non-physical (but still valuable) assets such as intellectual
property and goodwill. These assets are generally only listed on the balance sheet if they
are acquired, rather than developed in-house. Their value may thus be wildly understated
(by not including a globally recognized logo, for example) or just as wildly overstated.

Liabilities
A liability is any money that a company owes to outside parties, from bills it has to pay to
suppliers to interest on bonds issued to creditors to rent, utilities and salaries. Current
liabilities are due within one year and are listed in order of their due date. Long-term
liabilities, on the other hand, are due at any point after one year.

Current liabilities accounts might include:

current portion of long-term debt

bank indebtedness
interest payable
wages payable
customer prepayments
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dividends payable and others

earned and unearned premiums
accounts payable

Long-term liabilities can include:

Long-term debt includes any interest and principal on bonds issued

Pension fund liability refers to the money a company is required to pay into its employees'
retirement accounts
Deferred tax liability is the amount of taxes that accrued but will not be paid for another
year. Besides timing, this figure reconciles differences between requirements for financial
reporting and the way tax is assessed, such as depreciation calculations.

Some liabilities are considered off the balance sheet, meaning they do not appear on the
balance sheet.

Shareholder Equity
Shareholder equity is the money attributable to the owners of a business or its shareholders.
It is also known as net assets since it is equivalent to the total assets of a company minus its
liabilities or the debt it owes to non-shareholders.

Retained earnings are the net earnings a company either reinvests in the business or uses to
pay off debt. The remaining amount is distributed to shareholders in the form of dividends.

Treasury stock is the stock a company has repurchased. It can be sold at a later date to
raise cash or reserved to repel a hostile takeover.

Some companies issue preferred stock, which will be listed separately from common

stockunder this section. Preferred stock is assigned an arbitrary par value (as is common
stock, in some cases) that has no bearing on the market value of the shares. The common
stock and preferred stock accounts are calculated by multiplying the par value by the number
of shares issued.

Additional paid-in capital or capital surplus represents the amount shareholders have

invested in excess of the common or preferred stock accounts, which are based on par value
rather than market price. Shareholder equity is not directly related to a company's market
capitalization. The latter is based on the current price of a stock, while paid-in capital is the
sum of the equity that has been purchased at any price.

Par value is often just a very small amount, such as $0.01. 3

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Limitations of Balance Sheets

Although the balance sheet is an invaluable piece of information for investors and analysts,
there are some drawbacks. Since it is just a snapshot in time, it can only use the difference
between this point and another single point in time in the past. Because it is static, many
financial ratios draw on data included in both the balance sheet and the more dynamic
income statement and statement of cash flows to paint a fuller picture of what's going on with
a company's business.

Different accounting systems and ways of dealing with depreciation and inventories will also
change the figures posted to a balance sheet. Because of this, managers have some ability
to game the numbers to look more favorable. Pay attention to the balance sheet's footnotes
in order to determine which systems are being used in their accounting and to look out
for red flags.

Example of a Balance Sheet

The image below is an example of a balance sheet from Exxon Mobil (XOM) from
September 2018. You can see there are three sections on the sheet. The assets for the
period total $354,628. If you add up the company's total liabilities ($157,797) and its
shareholder equity ($196,831), you get a final total of $354,628—the same as the total
assets.

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Image by Sabrina Jiang © Investopedia 2020

Why Is a Balance Sheet Important?

The balance sheet is an essential tool used by executives, investors, analysts, and
regulators to understand the current financial health of a business. It is generally used
alongside the two other types of financial statements: the income statement and the cash
flow statement.

Balance sheets allow the user to get an at-a-glance view of the assets and liabilities of the
company. The balance sheet can help users answer questions such as whether the

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company has a positive net worth, whether it has enough cash and short-term assets to
cover its obligations, and whether the company is highly indebted relative to its peers.

What Is Included in the Balance Sheet?

The balance sheet includes information about a company’s assets and liabilities. Depending
on the company, this might include short-term assets, such as cash and accounts receivable,
or long-term assets such as property, plant, and equipment (PP&E). Likewise, its liabilities
may include short-term obligations such as accounts payable and wages payable, or long-
term liabilities such as bank loans and other debt obligations.

Who Prepares the Balance Sheet?

Depending on the company, different parties may be responsible for preparing the balance
sheet. For small privately-held businesses, the balance sheet might be prepared by the
owner or by a company bookkeeper. For mid-size private firms, they might be prepared
internally and then looked over by an external accountant.

Public companies, on the other hand, are required to obtain external audits by public
accountants, and must also ensure that their books are kept to a much higher standard. The
balance sheets and other financial statements of these companies must be prepared in
accordance with Generally Accepted Accounting Principles (GAAP) and must be filed
regularly with the Securities and Exchange Commission (SEC).

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Related Terms
What Is the Accounting Equation?
The accounting equation defines a company's total assets as the sum of its liabilities and
shareholders' equity.  more

What Is a Clean Balance Sheet?

A clean balance sheet refers to a company whose capital structure is largely free of debt.  more

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11/14/21, 3:54 PM Balance Sheet Definition: Formula & Examples

What Is a Liability?
A liability is something a person or company owes, usually a sum of money.  more

What Are Current Liabilities?

Current liabilities are a company's debts or obligations that are due to be paid to creditors within one
year.  more

What Is Fundamental Analysis?

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