What does the Balance Sheet balance?

 

The balance sheet is structured to show the amount and type of assets an enterprise owns and how those assets are funded. One side of the balance sheet shows what you have (assets) and the other side shows how you paid for it (debt and equity).

Assets can be purchased and paid for in two ways: with debt or with equity (or a combination of the two). What a company owes, the debts or loans, are called Liabilities; what a company owns is the Equity or Stock.

The Liabilities and Equity are equal to the Assets. They are two sides of the same coin and they must balance; hence the term Balance Sheet. This is a fundamental principal of Accounting called the Accounting Equation. Assets = Liabilities + Equity.

Balance Sheet Format

A Balance Sheet is typically organized in two columns with the Assets on the left and the Liabilities and Equity on the right. It is divided into subcategories with the most current types on top and the more long-term varieties towards the bottom.

Current Assets are ones like cash that can be used on short notice and Long term Assets are things like factories that would take longer to convert to cash. Current means short term; stuff that needs to be addressed within one year. Long-term means stuff longer than the next year.

Bills that need to be paid within the month are considered Current Liabilities and loans that are paid back over years are considered Long term Liabilities.

Equity is what the owners actually own. Equity is basically Assets less the Liabilities and is shown as accounts below the Liabilities on the left hand side. Equity is shown below the Liabilities because debt has senior claims on the assets. In the event of liquidation like a bankruptcy, the debt holders get paid from the sale of assets first and then anything left over goes to the equity holders.

Here is an example Balance Sheet to get and idea of the format; notice that the Total Assets equals the Total Liabilities plus Equity. For more info check out my book Reading and Understanding Financial Statements.