While the income statement highlights a company’s performance over time, the balance sheet shows its financial health at a point in time. It is one of the three primary financial statements and plays a significant role in company research and analysis.
So, what is it, why does it matter, and what components make it up?
What Is The Balance Sheet?
The balance sheet provides a snapshot of a company’s financial position at a single point in time. It tells investors and stakeholders what a company:
- Owns – Assets
- Owes – Liabilities
- And what’s left for its owners – Equity
The balance sheet is key to analysing financial risk and business longevity.
Why The Balance Sheet Matters
The balance sheet serves different purposes for different users.
For Investors
The balance sheet provides a window into a company’s:
- Capital Structure – The percentage of debt versus equity used to fund its operations.
- Liquidity – Its ability to settle short-term obligations easily and on time.
- Solvency – Its ability to meet its long-term debts and other financial obligations.
In simpler words, the balance sheet tells investors if a company is financially stable.
For Lenders
Before approving a loan, banks and other lenders assess a company’s balance sheet to ensure its creditworthiness. They consider a company’s ability to meet its short-term liabilities, specifically its interest payments and loan instalments, to certify that what is owed can be repaid.
For Students & Future Analysts
Understanding the balance sheet is fundamental to all things finance. It’s the source for ratios and figures like return on equity (ROE) and working capital – key pillars in equity research, financial modelling and valuation.
Reporting Periods
A company’s balance sheet shows its assets, liabilities and equity for different periods.
Quarterly Balance Sheets
Companies publish balance sheets as part of their quarterly earnings reports. These publications update analysts and shareholders on the company’s financial health and position at the end of each quarter.
Annual Balance Sheets
Annual balance sheets provide a broader view of a company’s financial health. They reflect the total results of the four quarters within a company’s financial year, offering insights into its long-term stability and overall financial position.
Fiscal Year vs Calendar Year
While some companies align their reporting with the calendar year (January to December), others use a fiscal year that better suits the nature of their operations.
For example, Microsoft ends its fiscal year in June, and Apple in September – aligning their reporting periods with their business cycles. In contrast, companies like Alphabet (Google’s parent company) and Meta Platforms report on a standard calendar year basis, ending in December.
The Balance Sheet Equation
This simple equation governs every balance sheet: the balance sheet equation.
Assets = Liabilities + Equity
It states that every company asset is funded by debt (liabilities) or owner contributions (equity). The equation forms the structural backbone of the statement and must always balance.
The balance sheet equation is sometimes called the accounting equation.
Balance Sheet Structure & Components
The balance sheet is split into three sections, each telling a different story.
Section 1: Assets – What A Company Owns
Assets are economic resources expected to produce future benefits. They’re presented under two headings on the balance sheet: current and non-current assets.
Current assets are short-term assets expected to be converted to cash or used up within twelve months. Some common examples include:
- Cash & Cash Equivalents – Physical cash and bank account balances.
- Accounts Receivable – Money owed by customers for purchasing on credit.
- Inventory – Raw materials, work-in-progress stock and finished goods for sale.
Non-current assets are long-term assets that aren’t expected to be converted to cash or used up within a year. Some common examples include:
- Property, Plant & Equipment (PPE) – Physical assets like buildings and machinery.
- Intangible Assets – Patents, copyrights, trademarks and goodwill.
- Long-Term Investments – Investments in other companies or financial assets.
Together, current and non-current assets equal total assets.
Section 2: Liabilities – What A Company Owes
Liabilities represent all financial obligations to outside parties. Like assets, they are presented under two headings.
Current liabilities are debts and other financial obligations due for settlement within a year. Common examples include:
- Short-Term Debt – Loans and other borrowing payable within a year.
- Accounts Payable – Money owed to suppliers for purchasing goods on credit.
Non-current liabilities are debts and other financial obligations not due for settlement within a year. Common examples include:
- Long-Term Debt – Bonds, loans and other debts with long-term maturities.
- Lease Liabilities – Long-term obligations under lease contracts.
- Pension Obligations – Future retirement benefits owed to employees.
Together, current and non-current liabilities equal total liabilities.
Section 3: Equity – The Owners’ Claim
Equity represents the residual interest in assets after liabilities are deducted. Different companies present different line items in the equity section, but the most common include:
- Share Capital (Common Stock) – The total cash stated at par value (the original value of the shares when they were first sold) that shareholders have contributed to the company.
- Share Premium (Additional Paid-In Capital) – The surplus cash a company receives for issuing shares above par value.
- Retained Earnings – The accumulated profits that weren’t distributed as dividends to shareholders.
When added, all the line items in this section equal total equity. Total equity is added to total liabilities to ensure the balance sheet equation balances.
Assets = Liabilities + Equity
Some Advanced Balance Sheet Concepts
Want to take your learning up a notch? Here are two more nuanced items that are derived from the balance sheet.
Working Capital
Working capital represents the capital a business uses in its day-to-day operations.
Working Capital = Current Assets – Current Liabilities
A positive working capital figure means a company has enough resources to cover its short-term obligations.
Tangible Book Value (TBV)
TBV highlights the value of the physical assets backing a company. It’s calculated by adjusting total equity for intangible assets.
Tangible Book Value = Total Equity – Intangible Assets
Tangible book value also provides an estimate of a company’s liquidation value – what the physical assets can be sold for in the case of bankruptcy.
Rounding It All Up!
The balance sheet provides a snapshot of a company’s financial health. It tells investors what a company owns, how much it owes, and what’s left for shareholders.
Combined with the other financial statements, the balance sheet helps form a 360-degree view of every business. Mastering it is a must for investors, analysts and anyone interested in finance.
