How to Read a Balance Sheet – Simple Format<\/span><\/strong><\/span><\/h1>\n

Reading a balance sheet is instrumental in understanding the business\u2019s financial position. This particular financial report is a snapshot of a moment in time. It can change dramatically in a minute; thus, understanding the perspective of the report and its respective sections will help you to be better informed.<\/span><\/p>\n

What is a balance sheet? It is considered one of the five basic financial reports of any company. In reality, most folks can only interpret the two most fundamental reports, the Profit and Loss and the Balance Sheet. The other three reports require a lot of background information to read and interpret the information correctly. Of course this didn\u2019t answer your question as to what is a balance sheet.\u00a0 <\/span><\/p>\n

This report basically identifies where the money came from, and where is it located. Huh? The best way to explain is to illustrate a basic transaction. Let\u2019s start out with the first day of business. On the first day, you as the owner purchased the stock and\/or made a capital contribution, normally in cash and so the balance sheet will display the following:<\/span><\/p>\n

\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 XYZ
\n<\/strong>.<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Bal<\/span>ance Sheet
\n<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Date
\n<\/span><\/span>Cash in a bank account \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $ZZ,ZZZ
\n<\/span>Total Assets\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $ZZ,ZZZ
\n<\/strong><\/span>Capital Contributed from Somebody (You) \u00a0$ZZ,ZZZ
\n<\/span>Total Liabilities and Capital\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $ZZ,ZZZ<\/strong><\/span><\/span><\/p>\n

Now note that the balance sheet is like a scale, on one side sits assets of some sort (where the value is located) whether physical in nature or intangible, like buying a patent or a copyright.\u00a0 All of this combined is referred to as Total Assets.\u00a0 On the other side sits two major groupings of where the money was sourced. You could borrow the money which is referred to as a liability or you could have contributed the money which is referred to as Capital.\u00a0 Both liabilities and capital are added together to create Total Liabilities and Capital.\u00a0<\/span><\/p>\n

<\/p>\n

Key Business Principle<\/span><\/p>\n

‘TOTAL ASSETS SHOULD ALWAYS EQUAL TOTAL LIABILITIES AND CAPITAL.’<\/span><\/strong><\/span><\/span><\/p>\n

The balance sheet presented in simple format. But business isn\u2019t that simple. Let\u2019s complicate this a bit. The very next day, you decide to buy a truck to use in the business operation. What happens now?<\/span><\/p>\n

Let\u2019s assume that you contributed $10,000 to the company on day 1, and on day 2, you buy a truck for $3,000. However, you didn\u2019t want to give up all that cash for a truck; so you decided to borrow $2,000 of the dollars. Let\u2019s walk through the result on the Balance Sheet. <\/span>For assets, you now have $9,000 in cash (the original $10,000 less the $1,000 put towards the purchase of the truck) and a truck worth $3,000. You have total assets of $12,000. Ok, now what does the other side of the balance sheet look? Well, there a liability of $2,000 (the amount we borrowed to buy the truck) exists along with the $10,000 originally invested into the company referred to as the capital.\u00a0 Now the balance sheet looks like this:<\/span><\/span><\/p>\n

\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 XYZ<\/strong>
\n.<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Ba<\/span>lance Sheet
\n<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Day 2
\n<\/span><\/span>Cash in the bank \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$9,000
\n<\/span>Fixed asset of a truck\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0 3,000
\n<\/span><\/span>Total Assets\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $12,000
\n<\/strong><\/span>Loan from bank for a truck\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$2,000
\n<\/span>Capital Invested\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0\u00a0 \u00a010,000
\n<\/span><\/span>Total liabilities and Capital\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $12,000<\/strong><\/span><\/span><\/p>\n

Note that they equal each other. Now why didn\u2019t the owner just expense out the truck? Well for one thing it\u2019s a fixed asset and we should depreciate this over time or as we use the truck in the day-to-day operations. But let\u2019s say that we did expense out the truck, because it\u2019s a piece of junk and we know it\u2019s only good for one haul of materials and then we have to ditch the truck.\u00a0 What happens here? Well, when a company makes a profit or loses money, that bottom line from the Profit and Loss statement ends up in the capital area of the Balance Sheet. The reason is that this benefit or loss (responsibility) belongs to the investor (you).\u00a0 This is recorded in the capital section of the balance sheet and is referred to as earnings. The word used by accountants is Retained Earnings. Anyway, the truck was used up in one day. We didn\u2019t earn any money, the only cost was the truck so the Profit and Loss says we lost $3,000. Now how does the balance sheet look? Let\u2019s see:<\/span><\/p>\n

\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0XYZ<\/strong><\/span>
\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Balance Sheet<\/span>
\n<\/span><\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Day 2 of Operations, Lost a Truck
\n<\/span><\/span>Cash in a bank\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $9,000<\/span>\u00a0 Remember, only $1,000 in cash for the truck was put up.
\n<\/span>Total Assets (Truck is gone)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$9,000
\n<\/strong><\/span>Loan from some institution for a truck \u00a0 \u00a0 \u00a02,000
\n<\/span>Capital Invested\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a010,000
\n<\/span>Loss from Profit & Loss\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 (3,000)<\/span> Simply stated, the value of the truck lost
\n<\/span>Total Liabilities and Capital\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$9,000<\/strong><\/span><\/span><\/p>\n

Notice how the two sides of the balance sheet equal each other. This is the primary tenet of a balance sheet, if you read a balance sheet and the two sides do not equal, then something is wrong.\u00a0 <\/span><\/p>\n

The balance sheet is divided into three major sections for Assets and two major sections for Liabilities and Capital. Below is a description of each of the major areas and in the next article on this subject, more details about reading and understanding these sections are explained.<\/span><\/p>\n

Assets<\/span><\/strong><\/h2>\n

Current Assets<\/span><\/strong><\/a> \u2013 this is generally cash and what is referred to as cash equivalents which include receivables from customers, inventory you purchase to resell, or raw materials you buy to turn into products. This section also includes short-term loans made to others including employees, and prepaid items for future services or materials.<\/span><\/span><\/p>\n

Fixed Assets<\/span><\/strong><\/a> \u2013 this is generally large ticket items such as heavy equipment, transportation vehicles, office equipment, storage units or items you buy that will be around for a long time and that are used on a daily basis.<\/span><\/span><\/p>\n

Non-Current Assets \u2013 these become more common as the company grows and prospers. They include deposits made or held for long-term contracts (like the utility deposit or rent deposit); goodwill, or the start-up costs you incurred to get this business going.<\/span><\/span><\/p>\n

Liabilities and Capital<\/span><\/strong><\/h2>\n

Liabilities- these are debts to various parties. They include suppliers and other vendors and they are referred to as Accounts Payable<\/span><\/strong><\/a>. We also include credit card debt (the company\u2019s credit card(s)) and short-term liabilities such as temporary notes, taxes owed, or payroll items. Other types of liabilities include long-term<\/span><\/strong><\/a>. This includes notes we use to purchase long-term assets such as fixed assets. Both of these combined make up Liabilities which is one major section of one side of the balance sheet.<\/span><\/span><\/p>\n

Capital<\/span><\/strong><\/a> \u2013 this comprises the invested amounts plus any earnings or losses incurred to date.<\/span><\/span><\/p>\n

Learning to read and understand a balance sheet is instrumental in evaluating a business operation. By understanding the simple format as explained above, you are on your way to learning more complex aspects of reading and understanding the balance sheet. Future articles will get involved in each of the respective areas and how to grasp what they really mean. Act on Knowledge<\/b>.\u00a0<\/span><\/p>\n