THE NUTS & BOLTS OF ACCOUNTING I

INTRODUCTION TO THE BALANCE SHEET

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Reading The Balance Sheet

By Investopedia Staff

A balance sheet, also known as a "statement of financial position," reveals a company's assets, liabilities and owners'
equity (net worth). The balance sheet, together with the income statement and cash flow statement, make up the
cornerstone of any company's financial statements. If you are a shareholder of a company, it is important that you
understand how the balance sheet is structured, how to analyze it and how to read it.

How the Balance Sheet Works

The balance sheet is divided into two parts that, based on the following equation, must equal each other, or balance
each other out. The main formula behind balance sheets is:

Assets = Liabilities + Shareholders\'

Equity
This means that assets, or the means used to operate the company, are balanced by a company's financial obligations,
along with the equity investment brought into the company and its retained earnings.

Assets are what a company uses to operate its business, while its liabilities and equity are two sources that support
these assets. Owners' equity, referred to as shareholders' equity in a publicly traded company, is the amount of money
initially invested into the company plus any retained earnings and it represents a source of funding for the business.

It is important to note that a balance sheet is a snapshot of the company's financial position at a single point in time.

Know the Types of Assets

Current Assets
Current assets have a life span of one year or less, meaning they can be converted easily into cash. Such assets
classes include cash and cash equivalents, accounts receivable and inventory. Cash, the most fundamental of current
assets, also includes non-restricted bank accounts and checks. Cash equivalents are very safe assets that can be
readily converted into cash; U.S. Treasuries are one such example. Accounts receivables consist of the short-term
obligations owed to the company by its clients. Companies often sell products or services to customers on credit; these
obligations are held in the current assets account until they are paid off by the clients.

Lastly, inventory represents the raw materials, work-in-progress goods and the company's finished goods. Depending
on the company, the exact makeup of the inventory account will differ. For example, a manufacturing firm will carry a
large amount of raw materials, while a retail firm caries none. The makeup of a retailer's inventory typically consists of
goods purchased from manufacturers and wholesalers.

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 THE NUTS & BOLTS OF ACCOUNTING I

Non-Current Assets
Non-current assets are assets that are not turned into cash easily, are expected to be turned into cash within a year
and/or have a lifespan of more than a year. They can refer to tangible assets such as machinery, computers, buildings
and land. Non-current assets also can be intangible assets, such as goodwill, patents or copyright. While these assets
are not physical in nature, they are often the resources that can make or break a company - the value of a brand name,
for instance, should not be underestimated.

Depreciation is calculated and deducted from most of these assets, which represents the economic cost of the asset
over its useful life.

Learn the Different Liabilities

On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside
parties. Like assets, they can be both current and long-term. Long-term liabilities are debts and other non-debt financial
obligations, which are due after a period of at least one year from the date of the balance sheet. Current liabilities are
the company's liabilities that will come due, or must be paid, within one year. This includes both shorter-term
borrowings, such as accounts payables, along with the current portion of longer-term borrowing, such as the latest
interest payment on a 10-year loan.

Shareholders' Equity
Shareholders' equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company
decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from
the income statement onto the balance sheet and into the shareholder's equity account. This account represents a
company's total net worth. In order for the balance sheet to balance, total assets on one side have to equal total
liabilities plus shareholders' equity on the other.

As you can see from the balance sheet above, it is broken into two areas. Assets are on the top and the below them
contains the company's liabilities and shareholders' equity. It is also clear that this balance sheet is in balance where the
value of the assets equals the combined value of the liabilities and shareholders' equity. Another interesting aspect of
the balance sheet is how it is organized. The assets and liabilities sections of the balance sheet are organized by how
current the account is. So for the asset side, the accounts are classified typically from most liquid to least liquid. For the
liabilities side, the accounts are organized from short to long-term borrowings and other obligations.

Reviewing Assets On The Balance Sheet

By Ryan C. Fuhrmann

A company’s balance sheet provides a snapshot of the assets it owns, liabilities it is responsible for, and whatever might
be left over when subtracting assets from liabilities that represents owners' capital or shareholders’ equity. Combined,
an analysis of a firm’s balance sheet indicates its financial strength, whether it can meet its obligations and how it
grows owners' capital. Below is a more detailed analysis of the asset side of the equation.

Assets Overview

A firm uses its assets to generate sales and bottom-line profits (net income) for shareholders. A healthy company will
continually grow its assets, by reinvesting profits back into the business. A very basic, high-level asset balance sheet will
include a mix of current and non-current assets totaled to indicate a firm's total assets.

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 THE NUTS & BOLTS OF ACCOUNTING I

Current assets are those that can be sold rather quickly, or specifically within a year. In fact, they will likely be turned into
cash and consist of working capital items, which generally consist of raw materials that are turned into final products
sold by the company. Non-current assets consist of items likely to be sold or used up after a year or much longer. These
are also logically referred to as long-term assets.

Common Assets

Below is an exhibit of fast-food giant McDonald’s (NYSE:MCD) balance sheet.

McDonald’s is a giant, globally diversified company with a market capitalization of nearly $100 billion. It operates a
pretty straightforward business that runs restaurants and serves basic meals consisting of hamburgers, French fries and
an increasing array of healthier items such as salads and smoothies.

Balance sheets are organized according to estimates of how long the assets are expected to last.

 Current assets (less than a year) come first and consist of cash and marketable securities, the last of which are
basically cash equivalents (items that can be quickly and readily converted to cash) such as money market
funds or other very short-term securities. McDonald’s converts what its customers in line purchase
(hamburgers, shakes, salads, etc.) at its restaurant into cash quickly, which means little risk to inventory or
accounts receivable.
 Prepaid expenses may sound more complicated but are simply operating expensesthat have been prepaid.
Prepaid insurance is a good example because premiums may be paid for six months in advance, meaning they
are prepaid for a number of months before they are recognized as an expense.

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 THE NUTS & BOLTS OF ACCOUNTING I

 McDonald’s other assets consist of its investments in affiliates that own and help operate its restaurants in
countries throughout the world.
 Goodwill is a more complicated category. McDonald’s defines it as “the excess of cost over the net tangible
assets and identifiable intangible assets of acquired restaurant businesses. The company's goodwill,
an intangible asset that doesn’t have any physical characteristics (and also includes trademarks, trade names,
or customer relationships), primarily results from purchases of McDonald's restaurants from franchisees and
ownership increases in subsidiaries or affiliates.” This last part relates to its investments in affiliates, and
goodwill overall means that McDonald’s has paid more for its acquisitions than is reflected on its balance
sheets.
 Its miscellaneous category is a catchall area and includes derivatives it uses to hedge currency risk and
commodity risks, such as the purchase of meat and potatoes for its burgers and French fries.
 On the long-term side of the asset equation (a year or more), McDonald’s property and equipment consists of its
physical restaurants and all equipment inside. It depreciates these assets over time, which accumulates on the
balance sheet and nets out in the final subcategory on its balance sheet.

Other Assets of Note

In many instances, a firm’s assets are explained clearly enough to know precisely what they are. For instance, a smaller
firm may list office supplies on its balance sheet in the current category. Long-term securities such as stocks and bonds
will exist for a number of firms, especially financial firms such as banks and insurance companies that are active
investors. Financial firms will generally hold a wide mix of short-term and long-term securities, with the first category
consisting of those readily available for sale and the second long-term, or out past a year.

On the more complicated side, deferred tax assets sound scary but are nothing more than taxes that have already been
incurred but have not yet been recognized on the profit and loss statement. Timing of tax payments can be very long-
term in nature, which affects when they are officially run through an income statement.

Reviewing Liabilities On The Balance Sheet

By Michael Schmidt

Of all the financial statements issued by companies, the balance sheet is one of the most effective tools in evaluating
financial health at a specific point in time. Consider it a financial snapshot that can be used for forward or backward
comparisons. The simplicity in its design makes it easy to view balances of the three major components with company
assets on one side, and liabilities and owners' equity on the other side. Shareholders' equity is the net balance between
total assets minus all liabilities and represents shareholders' claims to the company at any given time.

Assets are listed by their liquidity or how soon they could be converted into cash. Liabilities are sorted by how soon they
are to be paid. Balance sheet critics point out its use of book values versus market values, which can under or over
inflate. These variances are explained in reports like “statement of financial condition” and footnotes, so it's wise to dig
beyond a simple balance sheet.

Liabilities

In general, a liability is an obligation between one party and another not yet completed or paid for. In the world of
accounting, a financial liability is also an obligation but is more defined by previous business transactions, events, sales,
exchange of assets or services, or anything that would provide economic benefit at a later date. Liabilities are usually
considered short term (expected to be concluded in 12 months or less) or long term (12 months or greater). They are
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 THE NUTS & BOLTS OF ACCOUNTING I

also known as current or non-current depending on the context. They can include a future service owed to others; short-
or long-term borrowing from banks, individuals or other entities; or a previous transaction that has created an unsettled
obligation. The most common liabilities are usually the largest like accounts payable and bonds payable. Most
companies will have these two line items on their balance sheet, as they are part of ongoing current and long-term
operations.

AT&T 2012 Balance Sheet

Assets Liabilities
Current
Current Assets
Liabilities

Cash And Cash Equivalents$4,868,000 Accounts Payable $28,301,000

Short/Current
Short Term Investments - $3,486,000
Long Term Debt

Other Current
Net Receivables $13,693,000 -
Liabilities

Inventory -

Total Current
Other Current Assets $4,145,000 $31,787,000
Liabilities

Total Current Assets 22,706,000 Long Term Debt $66,358,000

Other Liabilities $52,984,000

Deferred Long
Long Term Investments $4,581,000 Term Liability $28,491,000
Charges

Property Plant and

$109,767,000 Minority Interest $333,000
Equipment

Goodwill $69,773,000 Negative Goodwill -

Intangible Assets $58,775,000

Accumulated Amortization - Total Liabilities $179,953,000

Other Assets $6,713,000

Deferred Long Term Asset Stockholders'
-
Charges Equity
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 THE NUTS & BOLTS OF ACCOUNTING I

Total
Total Assets $272,315,000 Stockholders' $92,362,000
Equity
Current Liabilities

Using the AT&T (NYSE:T) balance sheet as of Dec. 31, 2012, current/short-term liabilities are segregated from long-
term/non-current liabilities on the balance sheet. AT&T clearly defines its bank debt maturing in less than one year. For a
company this size, this is often used as operating capital for day-to-day operations rather than funding larger items,
which would be better suited using long-term debt. Like most assets, liabilities are carried at cost, not market value, and
under GAAP rules can be listed in order of preference as long as they are categorized. The AT&T example has a
relatively high debt level under current liabilities. With smaller companies, other line items like accounts payable (AP)
and various future liabilities like payroll, taxes and ongoing expenses for an active company carry a higher proportion.

AP typically carries the largest balances, as they encompass the day-to-day operations. AP can include services, raw
materials, office supplies or any other categories of products and services where no promissory note is issued. Since
most companies do not pay for goods and services as they are acquired, AP is equivalent to a stack of bills waiting to be
paid.

Examples of Common Current Liabilities

 Wages Payable: The total amount of accrued income employees have earned but not yet received. Since
most companies pay their employees every two weeks, this liability changes often.
 Interest Payable: Companies, just like individuals, often use credit to purchase goods and services to finance
over short time periods. This represents the interest on those short-term credit purchases to be paid.
 Dividends Payable: For companies that have issued stock to investors and pay a dividend, this represents the
amount owed to shareholders after the dividend was declared. This period is around two weeks, so this liability
usually pops up four times per year until the dividend is paid.

Current Liabilities Off the Beaten Path

 Unearned Revenues: This is a company's liability to deliver goods and/or services at a future date after being
paid in advance. This amount will be reduced in the future with an offsetting entry once the product or service is
delivered.
 Liabilities of Discontinued Operations: This is a unique liability that most people glance over but should
scrutinize more closely. Companies are required to account for the financial impact of an operation, division,
entity, etc. that is currently being held for sale or has been recently sold. This also includes the financial impact
of a product line that is or has recently been shut down. Since most companies do not report line items for
individual entities or products, this entry points out the implications in aggregate. As there are estimates used in
some of the calculations, this can carry significant weight. A good example is a large technology company that
has released what it considered to be a world-changing product line, only to see it flop when it hit the market. All
the R&D, marketing and product release costs need to be accounted for under this section.

Non-Current Liabilities

Considering the name, it’s quite obvious that any liability that is not current falls under non-current liabilities expected to
be paid in 12 months or more. Referring again to the AT&T example, there are more items than your garden variety
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company that may list one or two items. Long-term debt, also known as bonds payable, is usually the largest liability and
at the top of the list. Companies of all sizes finance part of their ongoing long-term operations by issuing bonds that are
essentially loans to each party that purchases the bonds. This line item is in constant flux as bonds are issued, mature
or are called back by the issuer.

Examples of Common Non-Current Liabilities

 Warranty Liability: Some liabilities are not as exact as AP and have to be estimated. It’s the estimated amount
of time and money that may be spent repairing products upon the agreement of a warranty. This is a common
liability in the automotive industry, as most cars have long-term warranties that can be costly.
 Lawsuit Payable: This is another liability that is estimated and requires more scrutiny. If a lawsuit is
considered probable and predictable, an estimated cost of all court, attorney and settled fees will be recorded.
These are common line items for pharmaceutical and medical manufacturers.

Non-Current Liabilities Off the Beaten Path

 Deferred Credits: This is a broad category that may be recorded as current or non-current depending on the
specifics of the transactions. These credits are basically revenue collected prior to it being earned and recorded
on the income statement. It may include customer advances, deferred revenue or a transaction where credits
are owed but not yet considered revenue. Once the revenue is no longer deferred, this item is reduced by the
amount earned and becomes part of the company's revenue stream.
 Post-Employment Benefits: These are benefits an employee or family members may receive upon his/her
retirement, which are carried as a long-term liability as it accrues. In the AT&T example, this constitutes one-half
of the total non-current total second only to long-term debt. With rapidly rising health care and deferred
compensation, this liability is not to be overlooked.
 Unamortized Investment Tax Credits (UITC): This represents the net between an asset's historical cost and
the amount that has already been depreciated. The unamortized portion is a liability, but it is only a rough
estimate of the asset’s fair market value. For an analyst, this provides some details of how aggressive or
conservative a company is with its depreciation methods.

maztraducciones@gmail.com.ar Maria Alejandra Zagari ©2014