Balance Sheet: Key to Financial Modeling and Accounting
A company’s balance sheet, or statement of financial position, is a financial statement which details the assets, liabilities, and stockholders’/owner’s equity at a specific point in time. Note that other financial statements detail information over periods of time. The balance sheet is used to define a company’s working capital, which is current assets minus current liabilities. The amount of assets and liabilities is also compared to the amount of stockholders’ equity. The balance sheet utilizes the accounting equation, which is:
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Most companies create a classified balance sheet, or one with amounts based on classifications. Assets are divided into current and noncurrent sections. Current assets include cash and cash equivalents that will turn to cash within a year. Current assets also include accounts receivable, inventory, and prepaid expenses on services rendered within a year.
Noncurrent, or fixed, assets include investments, which can be in other companies, cash values of life insurance policies, real estate held for investment, and bond sinking funds. The property, plant, and equipment category details depreciable assets such as buildings, equipment, machinery, furniture, fixtures, and vehicles. Also included is land, which will not depreciate in value. The intangible assets category details non-physical assets such as patents, copyrights, trademarks, franchises, and trade names. The value of an intangible asset is reported as the cost to acquire the asset, minus amortization or any write-downs. Note that intangible assets developed by the company itself are not reported. The other asset category details costs paid, but expensed for more than a year. This may include deferred incomes taxes and the costs of issued bonds.
Liabilities are sectioned into current and noncurrent. Current liabilities are required to be paid within one year and include accounts payable, current taxes, liabilities for accrued expenses, and provisions provided for warranties and court decisions. Noncurrent, or long-term, liabilities will not be paid for more than a year. These may include automobile and mortgage loans, bonds payable, and certain deferred income taxes.
Stockholders’ equity details paid-in capital, retained earnings, revaluation reserve, treasury stock, and accumulated other comprehensive income. Paid-in capital refers to contributions paid by investors when the company first issued shares. Retained earnings includes a company’s earnings which have been retained since the company’s inception, minus the earnings given out as dividends to stockholders.
Revaluation reserve assesses the fair market values of assets in order to determine any change in value. Treasury stock is stock which has been repurchased by the issuing company in order to reduce the amount of outstanding shares in the market. Accumulated other comprehensive income includes gains and losses from translating foreign currency, derivatives from cash flow hedges, sale securities, and employee benefit plans.
On a regular basis, balance sheets must be substantiated in order to ensure that the primary systems of records are in balance with the transaction and balance records in other systems. The balance sheet is reconciled, reviewed at the end of reconciliation, and certified to be accurate. Because the balance between accounts is important for maintaining accurate systems, substantiation is usually carried out every month, quarter, or year.
