What is the Balance Sheet?
The Balance Sheet, one of the core financial statements, provides a snapshot 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”.
What are the 3 Components of the Balance Sheet?
Conceptually, 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).
The three parts of the balance sheet are described in the following table.
What is the Definition of the Balance Sheet?
Balance Sheet: Beginner’s Guide (SEC.gov)
“A balance sheet provides detailed information about a company’s assets, liabilities and shareholders’ equity.
Assets are things that a company owns that have value. This typically means they can either be sold or used by the company to make products or provide services that can be sold. Assets include physical property, such as plants, trucks, equipment and inventory. It also includes things that can’t be touched but nevertheless exist and have value, such as trademarks and patents. And cash itself is an asset. So are investments a company makes.
Liabilities are amounts of money that a company owes to others. This can include all kinds of obligations, like money borrowed from a bank to launch a new product, rent for use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future.
Shareholders’ equity is sometimes called capital or net worth. It’s the money that would be left if a company sold all of its assets and paid off all of its liabilities. This leftover money belongs to the shareholders, or the owners, of the company.”
Beginners’ Guide to Financial Statements (Source: SEC.gov)
Fundamental Balance Sheet Equation
The fundamental accounting equation states that a company’s assets must be equal to the sum of its liabilities and shareholders’ equity.
The three components of the equation will now be described in further detail in the following sections.
How to Read the Balance Sheet?
1. What is the Assets Section of the Balance Sheet?
Assets describe resources with economic value that can be sold for money or have the potential to provide monetary benefits someday in the future.
On the balance sheet, a company’s assets are separated into two distinct sections:
- Current Assets → The assets that can or are expected to be converted into cash within one year.
- Non-Current Assets → The long-term assets 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 find a suitable buyer in the market.
The most common current assets are defined in the table below.
|Cash and Cash Equivalents||
|Accounts Receivable (A/R)||
The next section consists of non-current assets, which are described in the table below.
|Property, Plant and Equipment (PP&E)||
2. What is the Liabilities Section of the Balance Sheet?
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:
|Accounts Payable (A/P)||
The most common non-current liabilities include:
3. What is the Shareholders Equity Section of the Balance Sheet?
The second source of funding, other than liabilities, is shareholders’ equity, which consists of the following line items.
|Additional Paid-In Capital (APIC)||
|Retained Earnings (or Accumulated Deficit)||
|Other Comprehensive Income (OCI)||
Sample Balance Sheet Example: Apple (NASDAQ: AAPL)
The balance sheet of the global consumer electronics and software company, Apple (AAPL), for the fiscal year ending 2021 is shown below.
Apple Balance Sheet (Source: AAPL 10-K)
Balance Sheet Financial Analysis Ratios
While all financial statements are closely intertwined and necessary to understand the true financial health of a company, the balance sheet tends to be particularly useful for ratio analysis.
More specifically, the following are some of the most common ratio types used in practice to evaluate companies:
- Returns-Based Metrics → In conjunction with the income statement, returns-based ratios such as the return on invested capital (ROIC) can be utilized to determine how effectively a company’s management team can allocate its capital into profitable investments and projects. The companies with a sustainable economic moat tend to exhibit outsized returns relative to their competitors, which stems from sound judgment by management regarding capital allocation decisions and strategic decisions, such as geographic expansion, as well as the timely avoidance of poorly invested capital.
- Efficiency Ratios → Efficiency ratios, or “turnover” ratios, reflect the efficiency at which management can utilize the company’s asset base, investor capital, etc. All else being equal, a company with higher efficiency ratios relative to its peers should be more cost-effective and thus have higher profit margins (and more capital to reinvest in operations or future growth).
- Liquidity and Solvency Ratios → Liquidity ratios are more of a risk measure, with most metrics comparing a company’s asset base to its liabilities. In short, the more assets that belong to a company, especially liquid assets like cash sitting on the company’s balance sheet, the lower the liquidity risk of the company — both on a short-term (e.g. current ratio, quick ratio) and long-term (i.e. solvency ratios).
- Leverage Ratios → Leverage ratios, much like liquidity ratios, are meant to ensure that the company can continue to operate as a “going concern”, i.e. credit risk. The overreliance on debt is by far the most common cause of financial distress (and filing for bankruptcy) among corporations. The capital structure of each company is a critical decision that management must adjust accordingly to avoid the risk of defaulting on financial obligations and being forced into a reorganization (or straight liquidation) by its creditors. For example, a company’s debt balance can be compared to its total capitalization (i.e. debt + equity) to gauge the company’s reliance on debt financing.
Balance Sheet Calculator – Excel Template
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
How to Prepare a Balance Sheet?
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 Securities → Cash 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 all remotely similar line 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’ll input the rest of Apple’s historical data.
Note that in our model, the “Total Assets” and “Total Liabilities” line items include the values of the “Total Current Assets” and “Total Current Liabilities”, respectively. In other instances, it is common to see the two separated into “Current” and “Non-Current”.
Upon completion, we must ensure the fundamental accounting equation holds true by subtracting total assets from the sum of the total liabilities and shareholders’ equity, which is zero and confirms our balance sheet is indeed “balanced”.