REINSTATING THE BALANCE SHEET

What does a photograph tell us about someone? Exactly how they look in that moment of time, of course. A balance sheet is precisely that – a snapshot of a company in that moment of time. Put together a few balance sheets over time, and you begin to spin a story about where the company has been and the direction in which it is heading.

The Equation

Let’s define and understand the components of a balance sheet, starting with *the* equation that ties it together:

Assets - Liabilities = Equity

Put simply, this equation says: what a company owns (Assets) less what it owes (Liabilities) is equal to its net worth (Equity). Pretty straightforward.

Assets

Assets are resources with monetary value that a company owes or controls, and uses over time. Assets can be “tangible” like equipment or land, or “intangible” like the strength of your brand or your trademarks.

Assets are also classified as current or long-term. Current Assets are items that are expected to turn into cash within a year, like your inventory of goods. Fixed (or long-term) assets are expected to be held until no longer in use, such as office furniture or equipment.

Liabilities

Liabilities are financial obligations to external parties. Typically, we classify them as “current” or “long-term”. Current liabilities are obligations to be settled within a year like most bills, wages and sales taxes. Long-term liabilities last longer than a year, like most loans and mortgages.

Equity

Which brings us back to Equity. Equity is the net worth of the company - your holdings as a business owner, once all liabilities are covered using the assets owned. This is also referred to as the Book Value of Equity (BVE).

Note that a company's purchase price will often differ from the BVE. When a company is sold (or traded), its BVE is a useful baseline. But a potential buyer may be willing to pay more if she considers that a compay's is goodwill is undervalued or that some of its assets are worth more than reported on the balance sheet (and vice-versa).