The Balance Sheet
There are two kinds of financial statements and both follow a long-standing format of reporting. So if you understand how one set of financial statements is organized, you are well suited to follow any other corporate financial statement as well.
The first of these two is the balance sheet. It is given this name for two reasons. First, it summarizes the ending balances of all asset, liability, and net worth accounts as of a specific date.
The first component of the balance sheet is a category called current assets. These are all assets in the form of cash or that are convertible to cash within 12 months. Included are cash, accounts receivable, notes receivable, marketable securities, and inventory.
In order, after current assets, the next group is called long-term assets (also called 'fixed assets'). This is the net value of all capital assets minus accumulated depreciation.
After these two categories, additional asset groups include prepaid assets, deferred assets, and intangible assets. Prepays or deferrals are the values of expenses properly covering more than one year, and set up for annual amortization reducing the asset and transferring relevant portions to expense. Deferred assets are entire sums paid in advance but properly belonging to a future fiscal year. They are placed in the asset account until transferred to the expense category later. Intangible assets are all assets without physical value, including the assigned value of goodwill or covenants not to compete.
The asset accounts are added together to report the total of the corporation's properties, before being reduced by offsetting debts and obligations. It is important to use the subdivisions listed above, because so many ratios and indicators rely on distinctions between various asset classes.
Key PointThe subcategories of fi nancial statements are critically important. Many key ratios are based on isolated classes of accounts.
Key PointThe total of all liabilities plus net worth accounts is always equal to the total of all assets, without exception.
Next are the long-term liabilities, which are all debts owed by the company beyond the next 12 months. These include notes or contracts payable as well as the outstanding balances of bonds issued.
A final section included on this part of the balance sheet is not actually a liability, but a form of revenue received but not yet earned. All such deferred credits are assigned to this category. For example, a customer prepays a large purchase. The corporation has received the cash but it will not be earned until next year. In the current year, this is set up as a deferred credit.
The final section of the balance sheet is the net worth section. This includes capital stock and retained earnings as well as any other additional forms of net worth or adjustments. The sum of all net worth accounts is added to the sum of all liability accounts, and that total is identical to the sum of all asset accounts.
Note: How is the balance accomplished? The sum of liabilities and net worth is always equal to the value of all asset accounts because of double-entry bookkeeping. Every entry has a debit and a credit and these are equal in value. They may also be thought of as a plus and a minus. At any time, the sum of all accounts in the corporate books will add up to zero, because debits and credits offset one another.