The balance sheet is the financial statement that is typically used for figuring out the financial standing of the company. The typical items that you see on the balance sheet are Assets, Liabilities and Owner’s Equity.

The following equality is also commonly referred to as accounting equation:

Assets = Liabilities + Equity

Where:

• Assets are the balance sheet items that are owned by the company, such as buildings, vehicles, machinery, cash, investments, patents, and other items that can be both tangible (ones that can be physically touched such as buildings) and intangible (such as patents)
• Liabilities are the balance sheet items that are owed by company. Typically, they are divided into short-term (need to be repaid in under one year such as overdrafts or payables to employees and suppliers) and long-term (due in more than 12 months and include the long-term credit)
• Equity is showing the net financial standing or the difference between what company owns and owes

The modified version of the equation can be easier explained:

Assets – Liabilities = Equity

Essentially this equation tells us the story that everything that a company owns minus everything it owes is equal to the value attributable to shareholders if we were to shutdown the company today at the price assets are accounted for (not necessarily possible in the real world) and repay both debt and equity holders at the spot as well.

One important notion of the balance sheet is that it does not account for the future incomes and costs of the firm, hence you should not think of Equity as a fair representation of company’s worth. However, it is an outstanding tool to understand the current financial situation of the firm.

In the next articles on this topic, I will delve more into each of the high-level categories of the balance sheet.

Please note, none of the information on this blog represents the opinion of my employer and all information does not represent a financial advice.