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What does a balance sheet look like?

A company's balance sheet reflects their assets, liabilities and owners’ equity at a given point in time. Here's how to interpret each element of a balance sheet.

Tim Wu
Tim Wu

Head of Growth

Table of Contents



A balance sheet has either one or two columns, with assets appearing first followed by liabilities and net worth. As a business owner or investor, you can get a clear sense of a company’s financial health by looking at its balance sheet. This financial statement acts as a basis for calculating a number of helpful ratios, including the acid-test ratio and debt-to-equity ratio.

It is, therefore, a very important statement for determining a company’s solvency, book value, total assets, total liabilities, overall profitability etc. at any given moment in time. For this reason, every business – whether big or small – could benefit from preparing a balance sheet at least once a year.

What is a balance sheet?

A balance sheet is a financial statement that provides a snapshot of a company’s assets, liabilities and owners’ equity at a given point in time. Also known as a statement of financial position, it’s an important and necessary report because it provides a basis for determining a company’s capital structure as well as its rate of return for investors or owners. In other words, you can tell what a company owns, owes, as well as the amount invested and earned by shareholders just by looking at its balance sheet.

Balance sheet example

Below is Microsoft’s actual balance sheet for Q1 of the 2021 financial year.


Source: Microsoft


What are the elements of a balance sheet?

The three elements of a balance sheet are assets, liabilities and shareholders’ equity. While assets show how much a company owns, liabilities indicate how much it owes. Shareholders’ equity, on its part, is the value that owners or shareholders would theoretically receive as payment for shares if the business paid off its debts and closed.

As a rule, the total value of assets is always equal to the total sum of liabilities and shareholders’ equity. This is clearly visible in Microsoft’s balance sheet (example) above. The total value of assets is $301,001 million. The sum of liabilities and stockholders’ equity is also $301,001 million (i.e., 177,609 + 123,392). Below is a more detailed breakdown of elements of balance sheet:

Assets

An asset is a company-controlled resource that has economic value and one that the company expects will provide future benefits. This value can either be direct (e.g., cash) or indirect (e.g., inventory that can be sold for cash). Either way, assets are usually purchased in order to aid the company’s business operations. They are usually reported first when preparing a balance sheet (before liabilities and owners’ equity).

There are two types of assets, namely current assets and non-current assets. A balance sheet must capture both types of assets.

Current assets

These are assets that you can convert into cash in a year or less. They include cash and cash equivalents, prepaid expenses, accounts receivable (that are payable within a year), and inventory. The latter constitutes salable stock, including whatever is sitting in the warehouse.

In the balance sheet example above, we looked at the sum of Microsoft’s current assets. Usually when preparing a balance sheet, you will want to break down these assets into specific items. Here’s how Microsoft’s current assets look in the balance sheet:





 


Non-current assets

These are long-term assets that the company can’t easily convert into cash. They’re not expected to become cash within a year. Some examples of non-current assets are property, plant, equipment that’s not easy to sell and accounts receivable that’s not due for at least one year.

Non-current assets do include intangible assets like goodwill. These are things whose value isn’t tied to a physical item or property. Thus, they don’t actually exist in physical form but they add value to the company nonetheless.

When listing physical assets in a balance sheet, it’s important that you take into account their depreciation. Depreciation is defined as a reduction in the value of a physical asset over time owing to wear and tear. Think of it in terms of a brand-new car. The moment you drive it out of the dealership, it’s value drops. That reduction in value is depreciation. It represents the monetary cost that a company incurs in the functional life of an asset.

Non-current assets are usually itemized just below the “Total current assets”. Here’s how they appear in Microsoft’s balance sheet:



To find the total value of assets, add current and non-current assets. For example, Microsoft’s total value of assets for FY21 Q1 is $301,001 million (calculated as 177,077 current assets + 123,924 non-current assets).

Liabilities

Liabilities are debts that a company has. These are all the financial obligations that the company has to outside parties. They can either be short-term or long-term.


Short-term liabilities

Also known as current liabilities, short-term liabilities are debts that must be paid within one year. They include short-term accounts payable and short-term loans.

Just like current assets, you’ll want to itemize current liabilities when reporting them in a balance sheet. Here’s how Microsoft’s short-term liabilities appear on their balance sheet.




Long-term liabilities

Also known as non-current liabilities, these are debts and other obligations that are not due for at least one year from when the balance sheet was prepared. They are itemized immediately after short-term liabilities.



To find the total value of liabilities, add short-term liabilities with long-term liabilities. In our running example, that would be $177,609 million (calculated as 70,056 current liabilities + 107,553 long-term liabilities).

Shareholders’ equity

Shareholders’ equity or stockholders’ equity is the owner(s) residual claim on assets after all liabilities have been paid. It is, therefore, the difference between assets (what the business owns) and liabilities (what it owes).

Say, for example, that you have a sole proprietorship business. If the total value of its assets is $700,000 and the total value of liabilities is $250,000, then your equity is $450,000. It represents the net worth of your investment once you’ve paid off all the debts in the business.

It’s worth mentioning that shareholders’ equity actually represents what the company’s owners would get if the business were to pay all its debts and shut down. It does not represent the company’s market value or real-time value of shareholders’ stock. As such, shareholders’ equity tends to be more conservative, contrary to market value which is naturally volatile.

Here’s Microsoft’s shareholders’ equity, broken down into types of stock and earnings.





How do you read a company balance sheet?

As mentioned, there are three elements of a balance sheet: assets, liabilities and shareholders’ equity. Assets typically appear first, followed by liabilities and equity. These three elements point to the company’s resources, debts and owner(s) residual claim.

Therefore, if you want to know the company’s resources, you’ll look at its assets. Similarly, its liabilities will tell you how much the company is owed while shareholders’ equity indicates the value that stockholders have a claim to.

Balance sheet formula

The balance sheet adheres to the formula:

Assets = Liabilities + Shareholders’ Equity

Assets are on one side while the sum of liabilities and equity is on the other side. The two sides of the equation should always balance out. That’s because a company pays for all its resources (assets) by either taking out loans and credits (liabilities) or issuing equity (shareholders’ equity). Thus, the two sides of a balance sheet should always be equal.

For example, if your business takes a loan worth $10,000, then you’ll have acquired an asset in the form of cash that’s worth $10,000. At the same time, your debt (liability) will increase by $10,000, thus balancing out the two sides of the balance sheet equation.

What tools can help you analyze a balance sheet?

Shareholders, investors and analysts use the balance sheet to discover funding sources that a company uses to support its operations and growth. While you can get a rough picture just by looking at the assets, liabilities and equity, you’ll get a clearer picture using ratios. These ratios are analysis tools that can help interested parties to better understand a company’s capital structure. Below are three of the main ratios:

Debt-to-equity ratio

This ratio shows the proportion of debt and equity that a company is using to finance its assets. It shows whether a company’s capital structure is more reliant on debt or on equity. A high debt-to-equity ratio indicates that the company uses more debt than equity. On the other hand, a low ratio shows that the company uses more equity than debt.

To calculate debt-to-equity ratio, divide the company’s total liabilities by total stockholders’ equity.

Debt-to-equity ratio = total debt / total equity

Liquidity Ratios

Liquidity ratios show the ability of a company to quickly pay off its current liabilities using current assets. In short, it indicates whether a company can meet its short-term obligations using its short-term assets. There are three main liquidity ratios that you can calculate from a balance sheet. The three are:

Current ratio: this ratio measures the percentage of current assets to short-term liabilities. It’s calculated as current assets divided by current liabilities.

Current ratio = current assets / current liabilities

Quick ratio: also known as acid-test ratio, this ratio is calculated in the same way you calculate the current ratio. However, you will need to subtract inventory from current assets because it’s not a liquid asset. Therefore, quick ratio is current assets less inventory divided by current liabilities

Quick ratio = (current assets – inventory) / current liabilities

What is the importance of a balance sheet?

Having looked at elements of a balance sheet and what it looks like, you may be wondering, what’s the importance of this financial report?

For one, the Securities and Exchange Commission (SEC) requires all public companies to file quarterly balance sheets. The balance sheet is considered a required disclosure and you can always find it in a company’s investor relations section of the website.

Private companies are not legally required to disclose their balance sheets. However, they do prepare them for the use of directors, shareholders and other major stakeholders.

Alongside the cash flow statement and income statement, the balance sheet gives insight into how a company meets its expenses. It shows whether the company is run efficiently or not. Shareholders, investors, lenders, and other stakeholders use the balance sheet to analyze a company’s financial position.

For example, investors use ratios to figure out whether the company’s shares are worth buying. Shareholders use equity and retained earning values to know if the business is offering a good return on investment. Lenders, on their part, use ratios such as debt-to-equity and liquidity to know if the company is risking insolvency by sinking in debt.

In short, a balance sheet is a critically important financial statement. You may consider preparing it even if you own a small business.

Appendix 

Microsoft’s balance sheet for FY21 Q1 (in millions) (unaudited)
ASSETS
Total current assets $177,077
Property and equipment, net of accumulated depreciation $47,927
Operating lease right-of-use assets $9,047
Equity investments $3,103
Goodwill $43,890
Intangible assets, net $13,034
Other long-term assets $301,001
Total assets $301,001
LIABILITIES AND STOCKHOLDERS' EQUITY
Total current liabilities $70,056
Long-term debt $57,055
Long-term income taxes $28,204
Long-term unearned revenue $2,829
Deferred income taxes $187
Operating lease liabilities $7,753
Other long-term liabilities $11,525
Total liabilities $177,609
Total stockholders' equity $123,392
Total liabilities and stockholders' equity $301,001




















































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