Balance Sheet Definition
Balance Sheet Definition
Balance Sheet Accounts
Anything with an economic value that a company owns counts towards its assets.
It considers cash, equipment, property, rights and more. Non-cash assets are thought of in terms of liquidity, or how easily the asset can be converted into cash.
A company’s assets minus its liabilities represent the total value of a company and its resources.
A company’s liabilities refer to outstanding balances that reduce the effective financial power of a company.
Debt from a loan or the issuance of bonds are examples of liabilities.
Shareholder equity is the value of a company’s assets minus its liabilities.
This number, divided by the number of shares held, represents the value of each individual share.
Shareholders are investors that give a company a certain amount of money in exchange for ownership of the equivalent portion of that company.
The shareholder, therefore, now owns 50% of that company.
What Goes on a Balance Sheet
There are a number of factors when considering what is on a balance sheet.
A business balance sheet records the relationship between these three values—assets, liabilities, and shareholder equity.
It is a freeze-frame of a single point in time for a company, saying that at a particular moment, the company’s assets are equal to “x,” and their liabilities are equal to “y,” so their shareholder equity is equal to “z.”
For example, a balance sheet might declare that right now, company A has assets equaling $100,000, and liabilities equaling $20,000.
This makes their equity equal to $80,000. If they have sold 400 total shares, then each share is worth $200.
The “balancing” aspect comes into play as these values fluctuate.
For instance, if company A suddenly takes out a $10,000 loan from a bank, then its assets will increase to $110,000.
However, their liabilities will also increase by the same amount, to $30,000.
The shareholder equity remains at $80,000.
As company A pays off their loan, their liabilities will decrease, however, their assets will decrease at the same rate and by the same amount, since it takes company funds to pay the loan back.
As such, they will remain in balance.
If taken alone, the usefulness of a balance sheet is limited because it is only a record of certain values at a single point in time.
However, the data can be used to derive a number of statistics, such as the Debt-to-Equity ratio, which compares a company’s liability to its equity.
Pro-Tip (What This Means for Shareholders)
If company A sells pizza, then their $10,000 loan might have been to buy vehicles to make deliveries.
Remember that since assets are only counted in an abstract way, spending $10,000 in cash assets to obtain $10,000 worth of vehicles results in (discounting variations in liquidity) a $0 change in assets.
They will still be at $110,000, except that it will be split into $100K in cash assets and $10K in property assets.
If, by the time company A pays back the $10,000 loan, their vehicles allowed them to earn more money than they otherwise would have for that period—say a total of $20,000 at the end of the year—then company A will be able to pay back their loan to reduce both their liabilities and assets by $10,000.
However, they will retain their $110,000 in assets and $20,000 in liability, as well as a $10,000 profit, for a total net worth of $100,000.
If they retain the same 400 shares, each of their shares is now worth $250 instead of $200.
Company A’s stock has gone up, and the investors have earned money.
As mentioned above, balance sheets are limited by being time-specific snapshots of company value.
Therefore, they are most useful when tracked over time, analyzed, and compared to direct competition.