THE BALANCE SHEET DEMYSTIFIED - PART 1
This post is a work in progress
The balance sheet is confusing, and you shouldn’t feel bad if you don’t understand it. It is the financial statement most accounting texts spend the longest time on. To demystify it, we first need to define the terms we’re using: Assets, Liabilities, and Equity.
ASSETS (What you own)
Assets are anything the business owns that has value or could have value in the future. This includes obvious items, like a checking account, inventory, and vehicles, to not-so-obvious items, like mineral rights, collectible assets, logos, and websites.
We further divide assets into current and non-current assets. Current assets are anything which you expect to use within a year. Non-current assets are anything whose use will extend beyond a year. Cash and inventory are current assets. Buildings and vehicles are non-current assets.
People usually ask about tangible and intangible assets here. Examples of tangible assets are cash, inventory, and equipment. Things that have a physical presence. Easy to understand.
What about intangible assets? A good example of an intangible asset is the Starbucks logo. Patents, trademarks, and goodwill are also intangible. Most businesses don’t have intangible assets. The value of intangible assets is difficult to measure because it relies on future usefulness. For example, owning a patent on a VCR component in 1995 would be worth a lot of money. When the first DVD players became available to the public in 1996, the value of that patent would be reduced significantly.
LIABILITIES (WHAT YOU OWE)
Next, we come to the liabilities section. Liabilities are obligations that are owed to another party. We’re talking about items like loans, credit cards, and sales tax that a retail business has collected. This can also include unearned income or retainers, which are not recognized as income until the product or service is delivered, and accrued expenses (like auto insurance), which are billed in six or twelve month increments but paid monthly.
Much like assets, liabilities are further divided into two categories: current and long-term/non-current. Again, like assets, the division comes at a year. If you expect to repay the liability in less than a year, it’s current. If it’s more than a year, it’s long-term or non-current.
EQUITY (WHAT’S LEFT OVER)
Now we arrive at our final section: equity. Equity is the value of your ownership in the business. If you used the company’s assets to pay off its liabilities, the amount remaining would be equity.
Equity fluctuates based on the amount of assets and liabilities. Money the owner puts into or removes from the business also affects equity. Profits can increase equity and losses can decrease equity.