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Balance Sheet

Guide to Understanding the Balance Sheet

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Balance Sheet

Balance Sheet Formula

The balance sheet shows the carrying values of a company’s assets, liabilities, and shareholders’ equity at a specific point in time.

Hence, the balance sheet is often used interchangeably with the term “statement of financial position”.

The fundamental accounting equation states that at all times, a company’s assets must be equal to the sum of its liabilities and shareholders’ equity.

Fundamental Accounting Equation
  • Assets = Liabilities + Shareholders’ Equity

The assets of a company (i.e. the resources belonging to the company) must’ve all been funded somehow, and the two funding sources available for companies are liabilities and equity (i.e. how the resources were purchased).

  • Assets → Resources with positive economic value that can either be sold for money if liquidated or be used to generate future monetary benefits. For example, cash and short-term investments are a store of monetary value and can earn interest, accounts receivable are payments owed by customers that had paid on credit, and fixed assets (PP&E) are purchased via capital expenditures because these long-term assets (i.e. machinery) have the potential to generate positive cash flows in the future.
  • Liabilities → The unsettled obligations to third parties that represent future cash outflows — or more specifically, the “external” source of financing available to a company to fund the purchase and maintenance of assets. Unlike assets, liabilities are unsettled obligations to another party in the future and represent a future cash outflow to third parties, such as lenders that provided debt financing and the unmet payments still owed to suppliers/vendors.
  • Shareholders’ Equity → The difference between a company’s assets and liabilities and represents the remaining value if all assets were liquidated and outstanding debt obligations were settled. Equity represents the capital invested into the company and is the “internal” source of capital, which helps fund the purchase of assets and day-to-day operations — with the providers of capital ranging from the founders (i.e. if boot-strapped) and outside institutional investors. In addition, retained earnings represent the accumulated net profits kept by a company since inception, as opposed to the company issuing common or preferred dividends to shareholders.

Balance Sheet — Assets Section Line Items

Assets describe resources with economic value that can be sold for money or have the potential to provide monetary benefits someday in the future.

The assets section is ordered in terms of liquidity, i.e. line items are ranked by how quickly the asset can be liquidated and turned into cash on hand.

On the balance sheet, a company’s assets are separated into two distinct sections:

  1. Current Assets → The assets that can or are expected to be converted into cash within one year.
  2. Non-Current Assets → The long-term assets that are expected to provide economic benefits to the company in excess of one year.

While current assets can be converted into cash within a year, attempting to liquidate non-current assets (PP&E) can be a time-consuming process where substantial discounts are often necessary to be able to find a suitable buyer in the market.

The most common current assets are defined in the table below.

Current Asset Description
Cash and Cash Equivalents
  • The starting line item for practically all companies, cash and other highly liquid cash-like investments, such as commercial paper and certificate of deposits (CDs), are included here.
Marketable Securities
  • Marketable securities are short-term debt or equity securities owned by a company that can be liquidated to cash relatively quickly (and can be treated as a cash equivalent for modeling purposes).
Accounts Receivable (A/R)
  • Accounts receivable represents the unfulfilled payments owed to a company by its customers for products or services already delivered to them (and thus “earned”), yet the customer paid on credit, i.e. an “IOU” from customers.
Inventories
  • Inventories refer to the material used to produce the end product, such as raw materials, work-in-progress (WIP), and finished goods that are marketable and waiting to be sold.
Prepaid Expenses
  • Prepaid expenses describe the early payments issued in advance for goods and services that will not be provided until a later date, e.g. utilities, insurance, and rent.

The next section consists of non-current assets, which are described in the table below.

Non-Current Asset Description
Property, Plant and Equipment (PP&E)
  • PP&E, or fixed assets, are the long-term investments that are core to a company’s revenue model, such as buildings, machinery, tools, and vehicles.
Intangible Assets
  • Intangible assets refer to the non-physical assets belonging to a company such as patents, trademarks, intellectual property (IP), and customer lists — which are not recognized on the balance sheet until an acquisition occurs.
Goodwill
  • Goodwill is an intangible asset created to capture the excess of the purchase price over the fair market value (FMV) of an acquired asset, i.e. the premium paid.

Balance Sheet — Liabilities Section Line Items

Similar to the order in which assets are displayed, liabilities are listed in terms of how near-term the cash outflow date is, i.e. liabilities coming due sooner are listed at the top.

Liabilities are also separated into two parts on the basis of their maturity date:

  • Current Liabilities → The liabilities that are expected to be paid within one year.
  • Non-Current Liabilities → The long-term liabilities that are not expected to be paid for at least one year.

The most frequent current liabilities that appear on the balance sheet are the following:

Current Liabilities Description
Accounts Payable (A/P)
  • Accounts payable represent the unpaid bills owed to suppliers and vendors for services or products already received, yet were paid for on credit by the company.
Accrued Expenses
  • Accrued expenses are the expenses incurred by a company such as employee compensation or utilities, however, the payment has not yet been issued — most often because the invoice is still waiting to be processed.
Short-Term Debt
  • Short-term debt securities have maturity dates that are coming due within the next twelve months (including the current portion of long-term debt).

The most common non-current liabilities include:

Non-Current Liabilities Description
Long-Term Debt
  • Long-term debt represents any debt obligations with maturity dates that do not come due for at least one year, i.e. maturity exceeds twelve months.
Deferred Revenue
  • Deferred revenue, i.e. “unearned revenue”, represents customer payments received by a company in advance for goods or services not yet delivered.
Deferred Taxes
  • Deferred taxes are created from temporary timing discrepancies between the tax expense recorded under GAAP and the actual taxes paid — but the temporary timing differences between book and tax accounting eventually unwind over time to zero.
Lease Obligations
  • Lease obligations are contractual agreements that provide the company with the right to lease a fixed asset for an agreed-upon duration in exchange for regular payments.

Balance Sheet — Shareholders’ Equity Section Line Items

The second source of funding, other than liabilities, is shareholders’ equity, which consists of the following line items.

Shareholders’ Equity Description
Common Stock
  • Common stock represents a share of ownership in a company and can be issued when raising capital from outside investors in exchange for equity.
Additional Paid-In Capital (APIC)
  • APIC captures the amount received in excess of the par value from the sale of preferred or common stock.
Preferred Stock
  • Preferred stock is a form of equity capital often considered a hybrid investment, as it blends features of common equity and debt.
Treasury Stock
  • Treasury stock is a contra-equity account that stems from a company repurchasing shares that were previously issued but were repurchased by the company as part of a continuous or one-time share buyback (and those shares are no longer available to be traded in the open markets).
Retained Earnings (or Accumulated Deficit)
  • Retained earnings represent the cumulative amount of earnings kept by a company to date since the date of formation, i.e. the remaining profits not issued as dividends to compensate shareholders.
Other Comprehensive Income (OCI)
  • OCI is more of a “catch-all” line item for miscellaneous items such as foreign currency translation adjustments (FX) and unrealized gains or losses on available-for-sale securities.

Balance Sheet Example — Apple Inc. (AAPL)

The balance sheet of Apple (AAPL) for the fiscal year ending 2021 is shown below.

Apple Balance Sheet Example

Apple Balance Sheet (Source: 10-K)

Balance Sheet Example — Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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Balance Sheet Example Calculation

Suppose we’re building a 3-statement model for Apple (NASDAQ: AAPL) and are currently at the step of entering the company’s historical balance sheet data.

Using the screenshot from earlier, we’ll enter Apple’s historical balance sheet into Excel.

To abide by general financial modeling best practices, the hardcoded inputs are entered in blue font, while the calculations (i.e. the ending total for each section) are in black font.

But rather than copying every single data point in the same format as reported by Apple in their public filings, discretionary adjustments that we deem appropriate must be made for modeling purposes.

  • Marketable SecuritiesCash and Cash Equivalents: For instance, marketable securities are consolidated into the cash and cash equivalents line item because the underlying drivers are identical.
  • Short-Term Debt → Long-Term Debt: The short-term portion of Apple’s long-term debt was also consolidated as one line item since the debt schedule roll-forward is the same.

However, that does NOT mean that all similar items should be combined, as seen in the case of Apple’s commercial paper.

Commercial paper is a form of short-term debt with a specific purpose that is different from long-term debt. In fact, the 3-statement model of Apple we build in our Financial Statement Modeling (FSM) course treats the commercial paper like a revolving credit facility (i.e. the “revolver”).

Once all the historical data of Apple is entered with the proper adjustments to make our financial model more streamlined, we must ensure the fundamental accounting equation holds true by subtracting total assets from the sum of the total liabilities and shareholders’ equity, which comes out to zero and confirms our balance sheet is indeed “balanced”.

Balance Sheet Example

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