Understanding Your Balance Sheet

Author: Fundbox Team | November 21, 2013

Last week, we introduced the cash flow statement as one of the key financial statements that your company will produce. It reports all the cash generated and used by your company during a given period. Today, we’ll take a look at the important role that the balance sheet plays in your small business accounting. We’ll focus on the operating, financing, and investing activities that make up your balance sheet.

Operating Activities
This section of the balance sheet reports your company’s net income, converting it from accrual to cash basis. It does this by analyzing the changes in your current assets and liabilities. Fields that will be found in this section include:

Accounts Receivable – An asset attained by selling goods or services on credit (i.e. not a cash sale). This is often seen in contracts that indicate payment is due upon receipt of a service +30 days.

Inventory – A current asset that can be sold for revenue. The best example of this is a grocery store’s inventory. The price of a gallon of milk should factor in the cost of acquiring it, storing it, and staff necessary to prepare the milk for sale (placing it on the shelf).

Supplies – A current asset that indicates the cost of supplies currently in stock.

Prepaid Insurance – This refers to insurance premiums that have been paid in advance for a given period extending beyond the period of the balance sheet.

Accounts Payable – Accounts payable represent the amount your company owes for items and services purchased on credit.

Wages Payable – Wages payable are a current liability that indicate how much is owed to employees for hours worked that have not yet been compensated. This includes taxes that have been levied but not paid.

Income Taxes Payable – This is a current liability that reflects the amount of income taxes owed to local, state, and federal governments.

Unearned Revenues – This is a liability that reports payment received in advance of providing goods or services.

In addition to assessing current assets and liabilities, this section makes adjustments for depreciation (which we will be discussing next week) on long-term assets.

Financing Activities
This section of your balance sheet looks at the changes in balances for long-term liabilities and stockholders’ equity accounts. Essentially, it reports the issuance and/or repurchase of the company’s stocks and bond as well as short and long-term borrowings and repayments. Balances recorded in this section include:

Notes and Bonds Payable – This is a long-term liability that includes any bank loans our outstanding bonds that have been issued to the company and have not yet been paid.

Deferred Income Taxes – This represents the difference between the income tax expense associated with revenues and expenses reported on the business’ income statements and the actual income from a tax return.

Preferred, Common, or Treasury Stocks – Stocks refer to ownership of shares (common stock) in a business or corporation. Different classes of stocks will determine how shareholders can turn a profit. Preferred stockholders, for example, will be paid in dividends and typically do not share in the company’s earnings. Treasury stock refers to the company’s stock that has been repurchased from shareholders.

Retained Earnings – This refers to a shareholder’s equity account and reports the net income of the corporation from its start to the current date. It should be noted that dividends are typically excluded from this sum.

Investing Activities
While financing activities look at long-term liabilities, investing activities consider long-term assets. This section looks at the purchase or sale of long-term investments, property, equipment, and more. Long-term assets include:

Property – This refers to any land or buildings that have been purchased by and for the company. Land is generally the first asset listed under investing activities and is not generally subjected to depreciation. Buildings, on the other hand, are recorded minus the cost of the land and are depreciated based on their useful lifetime.

Vehicles, Furniture & Equipment – Large-ticket items are long-term assets that are classified on the balance sheet as property, plant, and equipment. With an exception of land, all such assets are subject to depreciation.

Stay tuned for our post next week that will walk you through the steps to calculate asset depreciation.

 

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