Balance Sheet: Explanation, Components, and Examples

What Is a Balance Sheet?

A balance sheet is a financial statement that shows what a company owns, what it owes, and the amount invested by shareholders at a specific point in time. The balance sheet details a company's assets, liabilities, and shareholders' equity. Investors and analysts use it to assess a company's financial health, perform fundamental analysis, and calculate key ratios such as liquidity, leverage, and return on equity.

How Balance Sheets Work

The balance sheet provides a snapshot of a company's finances at a moment in time. It cannot provide a sense of financial trends playing out within a company on its own. For this reason, the balance sheet should be compared with the other statements and sheets from previous periods.

Investors can get a sense of a company's financial well-being by using several ratios that can be derived from a balance sheet, including the debt-to-equity ratio and the acid-test ratio, along with many others. The income statement and statement of cash flows also provide valuable context for assessing a company's finances, as do any notes or addenda in an earnings report that might refer back to the balance sheet.

The balance sheet adheres to what is commonly called the accounting equation, with assets on one side and liabilities plus shareholders' equity on the other:

$\text{Assets} = \text{Liabilities} + \text{Shareholders' Equity}$Assets=Liabilities+Shareholders’ Equity

This formula is intuitive. That's because a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholder equity).

If a company takes out a five-year, $4,000 loan from a bank, its assets (specifically, the cash account) will increase by $4,000. Its liabilities (specifically, the long-term debt account) will also increase by $4,000, balancing the two sides of the equation. If the company takes $8,000 from investors, its assets will increase by that amount, as will its shareholder equity. These revenues will be balanced on the assets side, appearing as cash, investments, inventory, or other assets.

Special Considerations

As noted above, you can find information about assets, liabilities, and shareholder equity on a company's balance sheet. The assets should always equal the liabilities and shareholder equity. This means that the balance sheet should always balance, hence the name. If they don't balance, there may be some problems, including incorrect or misplaced data, inventory or exchange rate errors, or miscalculations.

Each category consists of several smaller accounts that break down the specifics of a company's finances. These accounts vary widely by industry, and the same terms can have different implications depending on the nature of the business. Companies might choose to use a form of balance sheet known as the common size, which shows percentages along with the numerical values. This type of report allows for a quick comparison of items.

There are a few common components that investors are likely to come across.

Components of a Balance Sheet

Assets

Accounts within this segment are listed from top to bottom in order of their liquidity. This is the ease with which they can be converted into cash. They are divided into current assets, which can be converted to cash in one year or less, and non-current or long-term assets, which cannot.

Here is the general order of accounts within current assets:

• Cash and cash equivalents are the most liquid assets and can include Treasury bills and short-term certificates of deposit, as well as hard currency.
• Marketable securities are equity and debt securities for which there is a liquid market.
• Accounts receivable (AR) refer to money that customers owe the company. This may include an allowance for doubtful accounts, as some customers may not pay what they owe.
• Inventory refers to any goods available for sale, valued at the lower of the cost or market price.
• Prepaid expenses represent the value that has already been paid for, such as insurance, advertising contracts, or rent.

Long-term assets include the following:

• Long-term investments are securities that cannot be liquidated within the next year.
• Fixed assets include land, machinery, equipment, buildings, and other durable, generally capital-intensive assets.
• Intangible assets include non-physical (but still valuable) assets such as intellectual property and goodwill. These assets are generally only listed on the balance sheet if they are acquired, rather than developed in-house. Their value may thus be wildly understated (by not including a globally recognized logo, for example) or just as wildly overstated.

Liabilities

A liability is any money that a company owes to outside parties, from bills it has to pay to suppliers to interest on bonds issued to creditors to rent, utilities, and salaries. Current liabilities are due within one year and are listed in order of their due date. Long-term liabilities, on the other hand, are due at any point after one year.

Current liabilities accounts might include:

• Current portion of long-term debt is the portion of a long-term debt due within the next 12 months. For example, if a company has 10 years left on a loan to pay for its warehouse, one year is a current liability and nine years are a long-term liability.
• Interest payable is the accumulated interest owed, often due as part of a past-due obligation, such as late remittance on property taxes.
• Wages payable is salaries, wages, and benefits to employees, often for the most recent pay period.
• Customer prepayments is money received by a customer before the service has been provided or product delivered. The company has an obligation to (a) provide that good or service or (b) return the customer's money.
• Dividends payable is dividends that have been authorized for payment but have not yet been issued.
• Earned and unearned premiums is similar to prepayments in that a company has received money upfront, has not yet executed on their portion of an agreement, and must return unearned cash if they fail to execute.
• Accounts payable is often the most common current liability. Accounts payable is debt obligations on invoices processed as part of the operation of a business that are often due within 30 days of receipt.

Long-term liabilities can include:

• Long-term debt includes any interest and principal on bonds issued
• Pension fund liability refers to the money a company is required to pay into its employees' retirement accounts
• Deferred tax liability is the amount of taxes that have accrued but will not be paid for another year. Besides timing, this figure reconciles differences between requirements for financial reporting and the way tax is assessed, such as depreciation calculations.

Some liabilities are considered off the balance sheet, meaning they do not appear on the balance sheet.

Shareholder Equity

Shareholder equity is the money attributable to the owners of a business or its shareholders. It is also known as net assets, as it represents the total assets of a company minus its liabilities, or the debt it owes to non-shareholders.

Retained earnings are the net earnings a company either reinvests in the business or uses to pay off debt. The remaining amount can be distributed to shareholders in the form of dividends.

Treasury stock is the stock a company has repurchased. It can be sold at a later date to raise cash, or even reserved to repel a hostile takeover.

Some companies issue preferred stock, which will be listed separately from common stock under this section. Preferred stock is assigned an arbitrary par value (as is common stock, in some cases) that has no bearing on the market value of the shares. The common stock and preferred stock accounts are calculated by multiplying the par value by the number of shares issued.

Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the common or preferred stock accounts, which are based on par value rather than market price. Shareholder equity is not directly related to a company's market capitalization. The latter is based on the current price of a stock, while paid-in capital is the sum of the equity that has been purchased at any price.

Importance of a Balance Sheet

Regardless of the size of a company or industry in which it operates, there are many benefits to reading, analyzing, and understanding its balance sheet.

First, balance sheets help to determine risk. This financial statement lists everything a company owns and all of its debt. A company will be able to quickly assess whether it has borrowed too much money, whether the assets it owns are not liquid enough, or whether it has enough cash on hand to meet current demands.

Balance sheets are also used to secure capital. A company usually must provide a balance sheet to a lender to secure a business loan. A company must also usually provide a balance sheet to private investors when attempting to secure private equity funding. In both cases, the external party aims to assess the financial health of a company, its creditworthiness, and whether it will be able to repay its short-term debts.

Managers can opt to use financial ratios to measure the liquidity, profitability, solvency, and cadence (turnover) of a company, and some financial ratios need numbers taken from the balance sheet. When analyzed over time or compared to competing companies, managers can better understand ways to improve a company's financial health.

Last, balance sheets can lure and retain talent. Employees usually prefer knowing their jobs are secure and that the company they are working for is in good health. For public companies that must disclose their balance sheet, this requirement gives employees a chance to review how much cash the company has on hand, whether the company is making informed decisions when managing debt, and whether they feel the company's financial health aligns with their expectations of their employer.

Limitations of a Balance Sheet

Although the balance sheet is an invaluable piece of information for investors and analysts, there are some drawbacks. Many financial ratios draw on data included in both the balance sheet, income statement, and statement of cash flows to paint a fuller picture of what's going on with a company's business.

A balance sheet is also limited due to its narrow scope of timing. The financial statement only captures the financial position of a company on a specific day. Looking at a single balance sheet by itself may make it difficult to determine whether a company is performing well. For example, imagine a company reports $1,000,000 of cash on hand at the end of the month. Without context, a comparative point, knowledge of its previous cash balance, and an understanding of industry operating demands, knowing how much cash on hand a company has yields limited value.

Different accounting systems and ways of dealing with depreciation and inventories will also change the figures posted to a balance sheet. Because of this, managers have some ability to game the numbers to make them look more favorable. Pay attention to the balance sheet's footnotes to determine which systems are being used in their accounting and to look out for any red flags.

Lastly, a balance sheet is subject to several areas of professional judgment that may materially impact the report. For example, accounts receivable must be continually assessed for impairment and adjusted to reflect potential uncollectible accounts. Without knowing which receivables a company is likely to actually receive, a company must make estimates and reflect its best guess as part of the balance sheet.

Example of a Balance Sheet

The image below is an example of a comparative balance sheet of Apple, Inc. This balance sheet compares its financial position as of September 2024 to that of the previous year.

In this example, Apple's total assets of $364.98 billion are segregated toward the top of the report. This asset section is broken into current assets and non-current assets, and each of these categories is broken into more specific accounts. A brief review of Apple's assets shows that their cash on hand decreased slightly, yet their non-current assets increased.

This balance sheet also reports Apple's liabilities and equity, each with its own section in the lower half of the report. The liabilities section is broken out similarly to the assets section, with current liabilities and non-current liabilities reporting balances by account. The total shareholders' equity section reports common stock value, retained earnings, and accumulated other comprehensive income. Apple's total liabilities increased, total equity increased, and the combination of the two reconciles to the company's total assets.

The Bottom Line

The balance sheet lists all of a business's assets, liabilities, and shareholders' equity. It provides anyone interested with a way to view and analyze the company's financial position as of a specific date and can be used in fundamental analysis by comparing the balance sheets of different periods.