Assets and Liabilities
Accounting is a wide field with many concepts, statements and documents. One of the most commonly heard of document/ statement is the Balance Sheet. Whether it be a corporation, partnership, sole proprietor, independent person, private limited, or some other corporation- all must prepare a balance sheet. This statement records and presents the summary of an individual or entity’s financial balances. It depicts the financial status by accounting the entity’s assets, equity, and liabilities, at a single point of time.
Most company’s produce this financial statement on regular basis (like monthly, quarterly or annually), depending upon market requirements. Whereas most individuals prepare a balance sheet at the end of the financial year (i.e. annually).
A balance sheet is generally used in conjunction with many other financial documents. The main idea behind preparing and studying a balance sheet is to understand the holder’s financial stability by comparing its liabilities to its assets. Looking at a balance sheet can help investors (other players) in understanding a company’s assets, working capital, and other financial fundamentals.
What are Assets and Liabilities?
Assets and liabilities are the two main components of a balance sheet. The document is divided into these two heads, which are further divided into sub-heads. And comparing these heads gives out the entity’s net worth. Let’s begin with discussing the two main subheads, and explain what they are.
Assets refer to anything of quantifiable value that the company owns, such as goods and resources. They are listed on the left side of the balance sheet. As mentioned before, the asset head further contains two more sub-heads, namely-
- These comprises of the assets that can be liquidated easily, i.e. converted to cash with ease.
- Generally, a company considers these are short-term assets that it can convert into cash within a year’s time.
- These include (but not limited to)- cash and cash equivalents, inventory, prepaid expenses, accounts receivable, and marketable securities.
The more current assets a business owns, the longer it can survive without borrowing money/ creating debts.
Non-current assets/ Fixed assets:
- In comparison, these are long-term assets that are more difficult to convert into cash in the short-term.
- In other words, these are physical possessions that last a company over a year.
- For example, long-term investments, land, patents, equipment, intellectual property, and trademarks etc.
Liability refers to anything (physical or monetary) that an organization owes to its debtor(s). These are listed on the right side of the balance sheet. Similar to the company assets, its liabilities are also classified into two sub-heads-
- In simplest terms, these are liabilities that are due within the period of one year.
- That is something that the company has to pay back within a year.
- These include- accounts payable, accrued expenses, etc.
- In contrast, these liabilities are the ones that the organization does not expect to repay within one year’s time period.
- These include long term obligations like bonds payables, loans, leases, and mortgages etc.
It is hence clear that assets are items that the organization owns, while liabilities are items that a company owes to others. Now that we are clear on this, let’s discuss how a beginner must go about preparing a balance sheet.
How to Prepare a Balance Sheet?
With the growing use of automation, many overlook what goes into preparing a Balance Sheet. However, learning the methodology of its preparation can enable you to easily spot errors and resolve them, in time. Here are the basic steps to follow when creating a basic balance sheet:
Date and Period of Reporting:
The first step in creating a balance sheet is to determining the date and time period of reporting. A balance sheet depicts the assets, liabilities and subsequently net worth/ shareholder’s equity of the organization at a given point of time- i.e. the reporting date. This reporting date is mostly the final say of the reporting period, the duration of which may vary.
For most companies that report on a quarterly basis, the reporting date is the final day of the respective quarter. Look at the following quarters and corresponding reporting dates:
- First Quarter (Q1) –March 31
- Second Quarter (Q2) –June 30
- Third Quarter (Q3) –September 30
- Fourth Quarter (Q4) –December 31
The reporting period here refers to the respective quarter for which the report is being made. Also, it is possible that the completion of the balance sheet may extend to a few weeks after the reporting period.
The next step is to identify and tally the assets your organization owns up until the reporting date. It is best to split the assets into individual line items and then present the totals. This makes it easy for the reader to understand the origin of the assets to begin with.
Following are the lists of line items that are a part of the two sub-heads under assets:
- Cash and cash equivalents
- Accounts receivable
- Short-term marketable securities
- Other current assets
Non-Current/ fixed Assets
- Intangible goods
- Long-term marketable securities
- Other fixed assets
These lists should make it easier for you to identify the assets. It is best to calculate the sub-total for each sub-head individually and then calculating total assets.
As with assets, you must also identify your organization’s liabilities. Also, it is again better to divide all the liabilities into line items and then calculating their total. Here are the lists of line items according to their subheads:
- Accounts payable
- Accrued expenses
- Current portion of long-term debt
- Deferred revenue
- Other current liabilities
Non-Current/ Fixed Liabilities
- Non-current deferred revenue
- Long-term debt
- Long-term lease obligations
- Other fixed liabilities
Again, as in case of assets, it is better to calculate the sub-total and then add overall liabilities.
This is the last component of the balance sheet, and is also listed on the right side, along with liabilities. So the next step is to identify and calculate the net worth. Other names for shareholder’s equity are net worth, capital, or even stockholder’s equity.
A company’s net worth refers to the value of the company after its liabilities are subtracted from its assets. For a sole proprietor the net worth is quite straightforward. But for a publicly held company, the calculation maybe be complicated depending on the stock types.
The common line items under this head are:
- Common stock
- Treasury stock
- Retained earnings
- Preferred stock
The equity should be positive because a negative equity means the company is in trouble. Generally the higher the equity value the better.
The accounting formula for the calculation of net worth is: Shareholder’s equity= Total Assets- Total Liabilities
Balancing the balance sheet
After calculating all the different components of the document, the next step is to compare the two sides of the document. First you need to add the liabilities of the company to the shareholder’s equity. And then compare the right side to the left.
When the total assets of the company are equal to the company’s liabilities plus equity, we say that the balance sheet is balanced. If however, the balances on both sides are not equal, this means there is a problem with the accounting data. There can be many issues like double counting, omission of data etc.
This compiles what a beginner must know about when it comes to assets, liabilities and preparing balance sheets. However, there is more to discuss about as we advance with the topics. So stay tuned for regular updates.