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CORPORATE FINANCE FINANCIAL STATEMENTS: BALANCE, INCOME, CASH FLOW,
AND EQUITY

Balance Sheet: Explanation,

Components, and Examples
What you need to know about these financial statements
By JASON FERNANDO Updated June 19, 2024

Reviewed by MARGARET JAMES

Fact checked by VIKKI VELASQUEZ

Part of the Series

H o w t o Va l u e a C o m p a n y

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

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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 LIVE
shareholders. Balance sheets can be used with other important financial
statements to conduct fundamental analysis or calculate financial ratios.

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.

Investopedia / Katie Kerpel

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How Balance Sheets Work LIVE

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.

Investors can get a sense of a company's financial well-being 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.

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

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).

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 $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.

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Important: 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 or exchange
rate errors, or miscalculations.

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. Companies might choose to use a form of balance sheet known as the
common size, which shows percentages along with the numerical values. This
type of report allows for a quick comparison of items.

There are a few common components that investors are likely to come across.

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Theresa Chiechi {Copyright} Investopedia, 2019.

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

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• Long-term investments are securities that will not or cannot be liquidated in

the next year. LIVE
• 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 is the portion of a long-term debt due

within the next 12 months. For example, if a company has a 10 years left on a
loan to pay for its warehouse, 1 year is a current liability and 9 years is a
long-term liability.
• Interest payable is accumulated interest owed, often due as part of a past-
due obligation such as late remittance on property taxes.
• Wages payable is salaries, wages, and benefits to employees, often for the
most recent pay period.
• Customer prepayments is money received by a customer before the service
has been provided or product delivered. The company has an obligation to
(a) provide that good or service or (b) return the customer's money.
• Dividends payable is dividends that have been authorized for payment but
have not yet been issued.
• Earned and unearned premiums is similar to prepayments in that a
company has received money upfront, has not yet executed on their portion
of an agreement, and must return unearned cash if they fail to execute.

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of an agreement, and must return unearned cash if they fail to execute.

• Accounts payable is often the most common current liability. Accounts
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payable is debt obligations on invoices processed as part of the operation of
a business that are often due within 30 days of receipt.

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 stock under 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

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calculated by multiplying the par value by the number of shares issued.

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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.

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

Importance of a Balance Sheet

Regardless of the size of a company or industry in which it operates, there are
many benefits of reading, analyzing, and understanding its balance sheet.

First, balance sheets help to determine risk. This financial statement lists
everything a company owns and all of its debt. A company will be able to
quickly assess whether it has borrowed too much money, whether the assets it
owns are not liquid enough, or whether it has enough cash on hand to meet
current demands.

Balance sheets are also used to secure capital. A company usually must provide
a balance sheet to a lender in order to secure a business loan. A company must
also usually provide a balance sheet to private investors when attempting to
secure private equity funding. In both cases, the external party wants to assess
the financial health of a company, the creditworthiness of the business, and
whether the company will be able to repay its short-term debts.

Managers can opt to use financial ratios to measure the liquidity, profitability,
solvency, and cadence (turnover) of a company using financial ratios, and some
financial ratios need numbers taken from the balance sheet. When analyzed
over time or comparatively against competing companies, managers can better
understand ways to improve the financial health of a company.

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Last, balance sheets can lure and retain talent. Employees usually prefer
knowing their jobs are secure and that the company they are working for is in
good health. For public companies that must disclose their balance sheet, this
requirement gives employees a chance to review how much cash the company
has on hand, whether the company is making smart decisions when managing
debt, and whether they feel the company's financial health is in line with what
they expect from their employer.

Limitations of a Balance Sheet

Although the balance sheet is an invaluable piece of information for investors

and analysts, there are some drawbacks. 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. For this reason, a balance alone may not
paint the full picture of a company's financial health.

A balance sheet is limited due its narrow scope of timing. The financial
statement only captures the financial position of a company on a specific day.
Looking at a single balance sheet by itself may make it difficult to extract
whether a company is performing well. For example, imagine a company
reports $1,000,000 of cash on hand at the end of the month. Without context, a
comparative point, knowledge of its previous cash balance, and an
understanding of industry operating demands, knowing how much cash on
hand a company has yields limited value.

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.

Last, a balance sheet is subject to several areas of professional judgement that

may materially impact the report. For example, accounts receivable must be
continually assessed for impairment and adjusted to reflect potential
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continually assessed for impairment and adjusted to reflect potential

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uncollectible accounts. Without knowing which receivables a company is likely
to actually receive, a company must make estimates and reflect their best guess
as part of the balance sheet.

Example of a Balance Sheet

The image below is an example of a comparative balance sheet of Apple, Inc.
This balance sheet compares the financial position of the company as of
September 2020 to the financial position of the company from the year prior.

Apple Balance Sheet.

In this example, Apple's total assets of $323.8 billion is segregated towards the
top of the report. This asset section is broken into current assets and non-
current assets, and each of these categories is broken into more specific
accounts. A brief review of Apple's assets shows that their cash on hand
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accounts. A brief review of Apple's assets shows that their cash on hand
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decreased, yet their non-current assets increased.

This balance sheet also reports Apple's liabilities and equity, each with its own
section in the lower half of the report. The liabilities section is broken out
similarly as the assets section, with current liabilities and non-current liabilities
reporting balances by account. The total shareholder's equity section reports
common stock value, retained earnings, and accumulated other comprehensive
income. Apple's total liabilities increased, total equity decreased, and the
combination of the two reconcile to the company's total assets. [1]

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 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

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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
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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). [2]

What Are the Uses of a Balance Sheet?

A balance sheet explains the financial position of a company at a specific point
in time. As opposed to an income statement which reports financial information
over a period of time, a balance sheet is used to determine the health of a
company on a specific day.

A bank statement is often used by parties outside of a company to gauge the

company's health. Banks, lenders, and other institutions may calculate
financial ratios off of the balance sheet balances to gauge how much risk a
company carries, how liquid its assets are, and how likely the company will
remain solvent.

A company can use its balance sheet to craft internal decisions, though the
information presented is usually not as helpful as an income statement. A
company may look at its balance sheet to measure risk, make sure it has
enough cash on hand, and evaluate how it wants to raise more capital (through
debt or equity).

What Is the Balance Sheet Formula?

In accounting, the footing is the final balance obtained by adding all the debits
and credits. A balance sheet, an important financial tool, calculates a
company's assets with its liabilities and equity. Total assets are calculated as
the sum of all short-term, long-term, and other assets. Total liabilities are
calculated as the sum of all short-term, long-term, and other liabilities. Total
equity is calculated as the sum of net income, retained earnings, owner

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equity is calculated as the sum of net income, retained earnings, owner

contributions, and shares of stock issued. The formula is: total assets =LIVE
total
liabilities + total equity.

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Part of the Series

H o w t o Va l u e a C o m p a n y

Introduction to Company Valuation

Financial Statements

1 Financial Statements

2 Balance Sheet
CURRENT ARTICLE

3 Cash Flow Statement

NEXT UP

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Fundamental Analysis Basics

Fundamental Analysis Tools and Methods

Valuing Non-Public Companies

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