Balance Sheet Part – 1: Introduction to Balance Sheet

Introduction to Balance Sheet

Now we come to the second financial statement, i.e. the Balance Sheet. 

A balance sheet is one of the financial statements that provides a snapshot of a company's financial position at a specific time. It is one of the fundamental components of financial reporting and is crucial for understanding and analysing a business's overall health and stability. The balance sheet follows the accounting equation:

Assets = Liabilities + Equity

To understand these balance sheet components, let's think of a balance sheet as a pizza.

Assets Are the Delicious Toppings

• Think of assets as all the delicious toppings on the pizza – pepperoni, mushrooms, cheese, and so on. In other words, these are the valuable things the company owns, like cash, inventory, property, plant, and equipment. The more and better the toppings on the pizza, the richer the pizza or, in the case of a company, the healthier the financial position. 

Liabilities Are the Slices Someone Owes to Others

• Now, imagine cutting the pizza into slices. Each slice represents a liability, i.e. debts and obligations the company owes to others, like loans, accounts payable, leases, or bonds. If the company has many liabilities, it owes more to various parties.

Equity Is the Slice the Company and Its Owners Get

• The remaining slices of pizza, not claimed by creditors (your liabilities), belong to the company and its owners. The equity slice represents a company's net worth or ownership interest. Just as individuals get the last slice of their pizza, shareholders get what's left after covering all the company's liabilities. 

The Whole Pizza Represents the Company

• The entire pizza, when put together, represents the company. If the pizza is cut into various slices, each slice (liability) and the toppings (assets) should be added to the whole pizza. 

Thus, the balance sheet shows us the value of assets and liabilities.

In simple language, assets generate money for you, directly or indirectly. In contrast, liabilities are those that take out money from your business. 

However, there is one major difference in the balance sheet compared to the other two financial statements, i.e., the balance sheet is an as-on-date statement rather than a period statement.

Therefore, whenever you see a balance sheet, the subline would be as on, say, March 31, 2023. This means that the balance sheet shows you the balances of assets and liabilities as of a particular date, which is March 31, 2023. Remember, it’ll be different on March 30, 2023 and April 1, 2023.

The balance sheet is a very important financial statement. Although it shows figures of just one day, it is really important for us to understand the position of assets and liabilities in a company. Some liabilities can even question the solvency of a company. 

Visualise Balance Sheet

A typical balance sheet will look like this:

	Assets	Equity and Liabilities
Long-lived physical assets	Fixed Assets	Current Liabilities	Short term obligations
Short lived assets	Current Assets	Non-Current Liabilities	Long term debt
Investment in securities and other businesses	Financial Assets	Other Liabilities	Other long-term obligations
Assets which are not physical	Intangible Assets	Equity	Shareholder's Equity

There are broadly two parts to a balance sheet:

1. Asset side
2. Liabilities side

Let’s look at each side in more detail:

Asset side of the balance sheet

1. Fixed Assets: Fixed assets are tangible assets having a life of more than a year, like machinery, buildings, factories, aeroplanes, etc., that the company requires to carry out its day-to-day operations.
2. Current Assets: These assets have a life span of less than a year and mainly consist of stocks or debtors related to the business.
3. Financial Assets: The business is left with excess cash from operations that it may either reinvest or pay dividends or invest in financial assets like stocks, bonds, or other companies listed or unlisted to generate income.
4. Intangible Assets: As covered in the P&L chapter, intangible assets are those assets that do not have a physical existence but are crucial for running a business. There are various examples of intangible assets like patents, goodwill, copyright, software, etc.

Now that you’ve got a broader picture of the asset side of the balance sheet, let’s look at the liability side.

1. Current Liabilities: These are the commitments that the company needs to fulfil within a year’s time, hence the name “short-term.” Think of getting a 90-day credit for the raw material a company purchased. This obligation must be met within 90 days and accounted for under payables. There may be a host of other short-term liabilities, like lease commitments, working capital loans, the portion of the long-term loans due this year, etc.
2. Non-current liabilities: A company requires money to run its operations, and the source of long-term money is dual: either take a long-term debt from a bank or bond issues or just go ahead and dilute equity. When a company goes ahead with the former plan, non-current liabilities are created. Thus, the long-term borrowings of the companies that are due for more than 12 months are referred to as a non-current liability. The company is expected to repay the debt over the longer term and thus requires regular interest commitments on the part of the company. 
3. Other Liabilities: These are miscellaneous liabilities that the company clubs under other liabilities. These can be from both current and non-current tenure. The best way to look through this breakdown is to review the notes on the accounts.
4. Shareholder’s Equity: Also called the book value, shareholder’s equity is the net asset available for the shareholders. This was Benjamin Graham’s favourite measure for a company’s value, and he regarded this as the minimum value the company must trade. However, times have changed, and so have valuations. What we mean by this is that many aspects of a company’s true value are not reflected in the book value, like the BRAND. There is no line time in the balance sheet showing us how much Coca-Cola’s brand is worth, right?

Shareholders’ equity comprises mainly two parts:

1. Share Capital: This is the number of shares issued multiplied by the face value per share. The face value of a stock is also referred to as the nominal value or par value, which is the rupee amount assigned to a share by the issuing company. It is purely an arbitrary value the company determines when the stock is initially issued and recorded on the stock certificate. It is very important to note that the face value is primarily an accounting concept and is different from the stock's market value, which is the current price at which the stock trades in the financial markets.
2. Reserves and Surplus: This is the record of all the profits that the company has retained over the years. It can be positive or negative. We all understand positive surplus, but you must ask how it can be negative. It can be negative for a company that has been making losses for many years.

We hope this chapter has given you a fair idea of a balance sheet and its major components. In the next chapter, we will dive deep into some of the prominent line items in the balance sheet.