Balance Sheet

How the Balance Sheet is Structured

Balance sheets, like all financial statements, will have minor differences between organizations and industries. However, there are several “buckets” and line items that are almost always included in common balance sheets. We briefly go through commonly found line items under Current Assets, Long-Term Assets, Current Liabilities, Long-Term Liabilities, and Equity.

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Current Assets

Cash and Equivalents

The most liquid of all assets, cash, appears on the first line of the balance sheet. Cash Equivalents are also lumped under this line item and include assets that have short-term maturities under three months or assets that the company can liquidate on short notice, such as marketable securities. Companies will generally disclose what equivalents it includes in the footnotes to the balance sheet.

Accounts Receivable

This account includes the balance of all sales revenue still on credit, net of any allowances for doubtful accounts (which generates a bad debt expense). As companies recover accounts receivables, this account decreases and cash increases by the same amount.

Inventory

Inventory includes amounts for raw materials, work-in-progress goods, and finished goods. The company uses this account when it reports sales of goods, generally under cost of goods sold in the income statement.

Non-Current Assets

Plant, Property, and Equipment (PP&E)

Property, Plant, and Equipment (also known as PP&E) capture the company’s tangible fixed assets. This line item is noted net of depreciation. Some companies will class out their PP&E by the different types of assets, such as Land, Building, and various types of Equipment. All PP&E is depreciable except for Land.

Intangible Assets

This line item will include all of the companies intangible fixed assets, which may or may not be identifiable. Identifiable intangible assets include patents, licenses, and secret formulas. Unidentifiable intangible assets include brand and goodwill.

Current Liabilities

Accounts Payable

Accounts Payables, or AP, is the amount a company owes suppliers for items or services purchased on credit. As the company pays off their AP, it decreases along with an equal amount decrease to the cash account.

Current Debt/Notes Payable

Includes non-AP obligations that are due within one year time or within one operating cycle for the company (whichever is longest). Notes payable may also have a long-term version, which includes notes with a maturity of more than one year.

Current Portion of Long-Term Debt

This account may or may not be lumped together with the above account, Current Debt. While they may seem similar, the current portion of long-term debt is specifically the portion due within this year of a piece of debt that has a maturity of more than one year. For example, if a company takes on a bank loan to be paid off in 5-years, this account will include the portion of that loan due in the next year.

Non-Current Liabilities

Bonds Payable

This account includes the amortized amount of any bonds the company has issued.

Long-Term Debt

This account includes the total amount of long-term debt (Excluding the current portion, if that account is present under current liabilities). This account is derived from the debt schedule, which outlines all the companies outstanding debt, the interest expense and the principal repayment for every period.

Shareholders’ Equity

Share Capital

This is the value of funds that shareholders have invested in the company. When a company is first formed, shareholders will typically put in cash. For example, an investor starts a company and seeds it with $10M. Cash (an asset) rises by $10M, and Share Capital (an equity account) rises by $10M, balancing out the balance sheet.

Retained Earnings

This is the total amount of net income the company decides to keep. Every period, a company may pay out dividends from its net income. Any amount remaining (or exceeding) is added to (deducted from) retained earnings.

How is the Balance Sheet used in Financial Modeling?

This statement is a great way to analyze a company’s financial position. An analyst can generally use the balance sheet to calculate a lot of financial ratios that can determine how well a company is performing, how liquid or solvent a company is, and how efficient it is.

Changes in balance sheet accounts are also used to calculate cash flow in the cash flow statement. For example, a positive change in plant, property, and equipment is equal to capital expenditure minus depreciation expense. If depreciation expense is known, capital expenditure can be calculated and included as a cash outflow under cash flow from investing in the cash flow statement.

Screenshot from CFI’s Financial Analysis Course.

Importance of the Balance Sheet

The balance sheet is a very important financial statement for many reasons.  It can be looked at on its own, and in conjunction with other statements like the income statement and cash flow statement to get a full picture of a company’s health.

4 important takeaways include:

1. Liquidity – Comparing a company’s current assets to its current liabilities provides a picture of liquidity.  Current assets should be greater than current liabilities so the company can cover its short-term obligations. The Current Ratio and Quick Ratio are examples of liquidity financial metrics.
2. Leverage – Looking at how a company is financed indicates how much leverage it has, which in turn indicates how much financial risk the company is taking. Comparing debt to equity and debt to total capital are common ways of assessing leverage on the balance sheet.
3. Efficiency – By using the income statement in connection with the balance sheet it’s possible to assess how efficiently a company uses its assets.  For example, dividing revenue into fixed assets produces the Asset Turnover Ratio to indicate how efficiently the company turns assets into revenue. Additionally, the working capital cycle shows how well a company manages its cash in the short term.
4. Rates of Return – The balance sheet can be used to evaluate how well a company generates returns. For example, dividing net income into shareholders’ equity produces Return on Equity (ROE), and dividing net income into total assets produces Return on Assets (ROA), and dividing net income into debt plus equity results in Return on Invested Capital (ROIC).

All of the above ratios and metrics are covered in detail in CFI’s Financial Analysis Course.

Video Explanation of the Balance Sheet

Below is a video that quickly covers the key concepts outlined in this guide and the main things you need to know about a balance sheet, the items that make it up, and why it matters.

As discussed the video, the equation Assets = Liabilities + Shareholders’ Equity must always be satisfied!

Learn More About the Financial Statements

CFI is the official global provider of the Financial Modeling and Valuation Analyst (FMVA)® designation. To continue learning and advancing your career as a financial analyst, these additional resources will be helpful:

• Income Statement
• Current Liabilities
• Three Financial Statements
• Three Financial Statement Model

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