The balance sheet is the document where assets, liabilities, and equity of a particular company or a person are recorded. It’s a crucial financial statement wildly used in accounting, investing, analytics, and other areas.
In this article we’ll explain what a balance sheet is, cover its essential components, and answer the most common questions.
Table of Contents
What is a Balance Sheet in Accounting?
The balance sheet is a permanent document with a record of what a company or an individual owns and owes at a specific date. It provides a snapshot and a summary of the current financial position.
The balance sheet is one of the three fundamental financial statements in accounting and financial modeling:
- Balance sheet
- Income statement
- Cash flow statement
Often, a company would prepare the balance sheet annually when their financial year is ending, but it’s common to do it quarterly as well.
Components and Elements
Every balance sheet must have 3 key components:
You can learn more about each element if you click on the links above. We wrote detailed articles about assets, liabilities, and equity previously. In short, assets represent everything a company owns (cash, property, equipment, etc.), liabilities show everything a company owes (various debts), and equity is the difference between these two elements.
When people refer to the balance sheet formula, they mean that the assets must be equal to the sum of liabilities and equity:
$$ A = L + E $$
At the end of any balance sheet, you can always see “Total liabilities and equity”, which should be equal to assets. If it’s the case, then the balance sheet is considered to be balanced. When these elements don’t match, perhaps there has been some kind of discrepancy that has to be found and resolved, which can cause quite a headache for an accountant.
The company’s assets are usually divided into current and non-current, and all the elements are listed according to their liquidity, i.e. cash goes first and something like goodwill, that can’t be exchanged for money easily, goes last.
What is the Balance Sheet Used for?
Why do companies prepare and publish this document in the first place? What’s its purpose?
The balance sheet is prepared for internal and external purposes. In the first case, it means that the balance sheet serves as a clear historical record of the company’s financial position, this is useful for analytical and statistical purposes. The case when a company has to publish this document if it’s a publicly-traded company that had an IPO, or some kind of a government non-for-profit organization, the main goal usually is to present the financial information in the most beneficial manner for the external parties. Sure, in both cases, in theory, the goal of ethical financial reporting is to disclose all the required information in a clear and truthful manner, but in some cases, the approach might be slightly different.
The balance sheet has to show the company’s financial position clearly, so investors, stakeholders and all who shell read it can see how this company is performing and what financial decisions its management execute. For example, if the balance sheet shows that an organization invested a significant portion of its cash to bonds, while it kept its assets in cash for many years previously, this is a quite important discovery that will affect the company’s profitability, efficiency, and its stock price.
How to Read and Analyze the Balance Sheet?
Although any college student who took Accounting 1 can understand the balance sheet in a general sense, reading and analyzing it can be hard. The numbers company presents aren’t as important as what those numbers can tell us. Plus, there are many ways to “play with” the way the figures are presented and allocated, and many of those ways are totally legal.
We already wrote an article about financial reports analysis before:
➤ Read also: How to Read an Annual Report?
The balance sheet, being a part of the annual report, can be analyzed similarly.
How to Make a Balance Sheet?
To create a balance sheet you can use one many popular accounting programs, but if the company is small or if you would like to make a balance sheet in the old way (or if you are a student with such an assignment) here is what you can do:
- Find good samples and templates online, there are billions of them
- Create a new document in MS Word or MS Excel. Excel is easier, but Word or PDF look better
- Make 3 sections for assets, liabilities and the net worth (shareholder’s or owner’s equity)
- Add the total for each section at the end (total assets, total liabilities, etc.)
- Don’t forget to mention whether the numbers are in thousands or millions, and the currency used
- Gather all the data for each element and enter it
- Highlight the most important elements like totals, or make the font bold
- Be consistent: use the same font, size, and format
- Make sure that the formatting is done properly: check the alignment, cell format, etc.
- Give the final version of the document to a professional to get a second external opinion
“The Balance” website has a short, yet helpful article about preparing a balance sheet that you might want to check out. Plus, there is a nice article from the excel-university.com which shows step by step guide on creating a balance sheet in Excel. Many small businesses prefer to create the balance sheet in Excel, but actually, it’s better to save the final copy in MS Word or PDF and add some additional pages with comments that explain significant changes in values in the last year.
It’s unlikely that someone would make only the balance sheet without creating an income statement and the full financial report too. These three documents are often tightly connected.
Let’s look at Tesla’s recent SEC Filings, a 10-K annual report, in particular, that was filed Feb 13, 2020.
As you can see, Tesla’s balance sheet has all the essential elements: assets (current, non-current), liabilities (current, non-current), equity.
Note that the balance sheet shows Tesla’s values as at December 31, 2019, and December 31, 2018. Other companies could publish their reports on a different date.
What can we conclude from this balance sheet with a quick and brief analysis?
- In 2019 Tesla had much more assets (34,000 million US dollars) than liabilities (26,199), which is a positive sign
- Total shareholder’s equity grew from 4,923 to 6,618 for a year, however, this is mostly due to the additional paid-in capital
- As expected from a manufacturing company, Tesla has a significant portion of its assets, more than 10,000, in PPE (property, plant, and equipment), but another 6,000 of assets in solar energy systems look a bit concerning. It’s known that now SolarCity, a renewable energy company, is Tesla’s subsidiary, but the fact that those energy operations are mixed with car manufacturing in one report could be confusing to some people.
- Tesla’s debt equals to 11,634, which is almost 50% of the total liabilities
Overall, Tesla always felt like a non-typical company, and perhaps the classic approach to financial analysis wouldn’t be quite applicable here. After all, this company operates within a new and emerging market, and it’s controlled by an eccentric individual with a significant base of rich supporters. Therefore, as long as Elon Musk expanding production while maintaining products' quality and trying to reduce prices, his company should be fine. In a long-term perspective, the combination of solar technologies for homes and electric cars looks promising, and even strange Cybertruck or other Musk’s idea can’t stop Tesla’s success.
In some cases like this one, analyzing only the company’s financial data might not be enough, and stepping outside of the box of accounting even for a second might be extremely helpful to see the full picture.
Personal vs Business
The balance sheet is used not only in business but also in personal finance.
In this case, the balance sheet is often called a statement of net worth, or a statement of financial position.
Any individual can prepare a personal balance sheet and list the assets and liabilities that he/she has, often a bank would do it for you automatically, but a bank wouldn’t include things that not on the bank’s balance (property, car, etc.). You can make your own balance sheet and discover that actually many people have much more wealth than they think, because the majority of the people think only about the income statement (salary, debt payments, expenses, etc.), while their assets are often ignored.
Investopedia has a helpful article on evaluating your personal financial statement that you might be useful when you create your personal balance sheet.
For an investor, a part of the balance sheet might be extracted from an application that tracks their investments. We at Easy Portfolio are developing such an app that tracks current prices of the investments (stocks, bonds, etfs), so at the end of the year, this data can be downloaded and placed in the personal balance sheet easily.
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