What is the Balance Sheet?
The balance sheet is one of the four financial statements produced by a company every quarter and year.
In contrast to the income statement, cash flow statement, and statement of comprehensive income, which cover a time period (quarter or year), the balance sheet represents a snapshot in time.
It lists all assets, liabilities and equity for the reporting date and contains numbers that can give us crucial insights into whether a company is a good investment or not.
Structure of the Balance Sheet
The balance sheet consists of three main sections: assets, liabilities and shareholders’ equity.
The assets are what the company owns, liabilities are what the company owes to others, and shareholders’ equity is effectively what the shareholders own.
The amount of assets needs to balance the sum of liabilities and shareholders’ equity. Hence the term “balance sheet”.
This relationship is expressed by the accounting equation:
Assets = Liabilities + Shareholders’ Equity
Part 1: Assets Section
The assets section consists of two main parts: current assets, and non-current assets. Together, they make up the total assets.
Current assets are liquid assets that are either cash or can be converted to cash within 1 year.
Non-current assets are long term assets.
Current Assets
Cash & Short-Term Investments
Cash is the cash currently in the bank, whereas short-term investments include assets like short-term certificates of deposit (CDs), short-term treasury bonds, and assets that can be converted to cash quickly. These are also called liquid assets.
Total Inventory
Total inventory sums up the production value of a company’s inventory.
This is a useful number for investors as it allows us to track inventory levels. Are inventory levels piling up? This can be a red flag.
Total Receivables
Any outstanding payments to the company for products and services that were purchased by customers on credit.
It can be an indicator about how efficient a company is at collecting payments, which is beneficial for cash flow.
Prepaid Expenses
Any expenses for goods and services the company paid in advance, without receiving the goods or services yet (e.g., unexpired insurance premiums).
Other Current Assets
Any non-cash items that are due within a year, but not yet on the company’s accounts as cash (e.g., deferred income tax recoveries).
Total Current Assets
Sum of all current assets.
Non-Current Assets
Property, Plant and Equipment
As the name suggests, this account lists the value of a company’s property, manufacturing plants and equipment. The value is the initial cost, minus any depreciation.
Goodwill
Goodwill is an intangible asset that gets recorded when a company acquires another company for a price higher than the acquired company’s book value of equity. The difference between the price paid, and the book value, is goodwill.
Other Intangibles
This account lists the value of any intangible assets that were acquired through acquisition of other companies. This includes brand recognition, franchises, or intellectual property, such as patents, copyrights and trademarks. Any patents developed in-house through research & development cannot be stated on the balance sheet and therefore are not listed here. The costs for their development, instead, are recorded as an expense on the income statement.
Long-Term Investments
Long-term investments is an asset account for any investments that a company intends to hold for more than one year, including stocks, bonds, real estate, and a company’s affiliates and subsidiaries.
Other Assets
Other assets are any assets with useful lives above one year that didn’t fit in any other non-current asset accounts.
Total Assets
Total assets is the sum of all asset accounts.
Part 2: Liabilities and Shareholders' Equity
Besides assets, the balance sheet contains two additional parts: liabilities and shareholders’ equity.
The liabilities section lists anything a company owes to others, such as banks, suppliers, and employees.
The shareholder’s equity section lists what belongs to the shareholders.
Liabilities Section
The liabilities are split into current and non-current liabilities, which summed up are the total liabilities.
Current Liabilities
Accounts Payable
Accounts payable is money owed to suppliers for goods and services that the company paid for on credit. For example, when a pharmaceutical company orders lab supplies and gets the invoice to pay within 30 days, the amount due is recorded under Accounts Payable.
Accrued Expenses
Accrued expenses are liabilities such as accrued rent payable and sales tax payable. These are expenses the company incurred, but hasn’t been asked to pay yet.
Short-Term Debt
Short-term debt is a liability owed by the company and due within the fiscal year. Examples include commercial paper (a type of unsecured debt issued by companies), or short-term bank loans. Short-term debt is a useful metric when compared to long-term debt. The ratio can indicate how risky a business is.
Long-Term Debt Due
Long-term debt due is the proportion of long-term debt that needs to be paid back within the current fiscal year. While most businesses don’t have an obligation to pay long-term debt back on a yearly basis, some companies do.
Other Current Liabilities
Other current liabilities is a summary account for any short-term liabilities that don’t fit in any of the other current liabilities accounts.
Total Current Liabilities
Total current liabilities is the sum of all current liabilities and is a useful number to calculate the current ratio, a measure of financial stability.
Non-Current Liabilities
Long-Term Debt
Long-term debt is any money owed further out than the current fiscal year. Little or no long-term debt compared to earnings is a good sign of financial stability.
Deferred Income Tax
Deferred income tax is tax owed that hasn’t been paid yet.
Minority Interest
To understand minority interest, let’s assume that Company A owns the majority of Company B’s stock. Let’s say 90%. Because it owns more than 50% and has a controlling interest, Company A is allowed to transfer Company B’s entire assets and liabilities onto its own balance sheet. To reflect that Company A owns only 90%, the value of the minority interest that remains (100 – 90% = 10%) with Company B is recorded as the minority interest on Company A’s balance sheet.
Other Liabilities
Other liabilities are any non-current liabilities that don’t fit in the other categories. Some examples include unpaid fines or interest on taxes due.
Total Liabilities
Total liabilities is the sum of all current and non-current liabilities.
Shareholders' Equity Section
The shareholder’s equity part of the balance sheet summarizes what belongs to the shareholders, including preferred and common stock, additional paid in capital, retained earnings, and treasury stock.
Preferred Stock
Shareholders of preferred stock have the right to a fixed or adjustable dividend, whereas common stock shareholders don’t necessarily receive a dividend. However, preferred stock shareholders don’t have the right to elect the board of directors, whereas common stock shareholders do.
Most companies don’t issue preferred stock when raising new capital, and instead choose to only offer common stock. The reason is this: in contrast to interest paid on loans, which is deductible from pretax income, the dividends paid on preferred stock (and common stock, should there be a dividend) are not, therefore making preferred stock an expensive option to raise capital.
Thus, many balance sheets don’t list any value for preferred stock, because they didn’t issue any.
Common Stock
Common stock refers to all common shares that were given out to the public when the company raised capital. The value recorded on the balance sheet is the par value of the shares.
A par value is simply the original value of the share as stated in a company’s charter, but it doesn’t reflect the actual value of the shares. For example, Thermo Fisher carries each common share at a par value of $1 (this information is listed in the annual reports), even though the value of each share is much higher.
Additional Paid In Capital
Additional paid in capital refers to the additional amount a company receives from stock issued in an initial public offering (IPO) or secondary offering above the par value of the stock. It represents the premium that investors are willing to pay for the stock.
Retained Earnings
Retained earnings are any net earnings left over after paying dividends and buying back shares. Thus, companies that have positive net earnings, don’t pay out dividends, and don’t buy back shares, retain 100% of their earnings, and these get added to the pool of retained earnings every reporting period.
These retained earnings can then be used in the future when value-creating investment opportunities present themselves, for instance for projects or to acquire other companies.
If a company reports a net loss one year, this amount gets subtracted from the retained earnings.
Retained earnings is a crucial number for investors. If retained earnings shrink over time, or the company doesn’t increase its retained earnings through additions, the company is not growing its net worth. If the net worth doesn’t grow long-term, what do you think the share price will do long-term?
Treasury Stock
When a company repurchases its own preferred or common stock, the value is recorded on the treasury stock account.
In general, share buybacks are beneficial for shareholders as the company value is distributed over less shares after the stock repurchase.
Total Shareholders' Equity
The total shareholders’ equity is the sum of the preferred and common stock accounts, additional paid in capital, retained earnings, other equity, minus the treasury stock.
Total shareholders’ equity is also called the net worth, book value, or equity book value of the company. This is because it is the result of subtracting the total liabilities from the company’s total assets. Similar to your own personal net worth, which is your personal liabilities subtracted from your personal assets.
For investors, total shareholders’ equity is extremely valuable because it is the denominator of return on equity (ROE), a critical number to assess how efficient a company is at allocating capital.