As discussed in our Intro to Financial Accounting tutorial, the balance sheet shows a company’s assets at a specific time, for example, at 12/31/2018. Based on the central accounting identity Assets = Liabilities + shareholders equity, it also shows how the company paid for those assets: either in liabilities (debt or other liabilities we’ll discuss below) or contributions from owners (either direct capital contributions or through undistributed, or retained, earnings).
Let’s dive into the first section, Assets, of the balance sheet. The Asset section starts with the most liquid assets, including cash and short-term investments. After those, you’ll typically see other current assets, including accounts receivable (money owed from customers), prepaid expenses (expenses paid before the benefit is realized, like prepaying rent), and deposits. After the current assets, you’ll see other assets, including PP&E (plant, property, and equipment), intangible assets (like patents), deferred tax assets (when future taxes are expected to be lower due to net operating losses or other tax benefits), and goodwill (strictly arises from a merger or acquisition).
That deals with the “left side” of the balance sheet. Now let’s discuss the “right side”, or how companies financed those assets.
Like the asset section, liabilities starts with current liabilities (liabilities expected to be paid within 12 months). Current liabilities include short-term debt (debt or the portion of debt due with 12 months), accounts payable (money owed to suppliers), accrued expenses (variety of expenses including salaries that have accrued but not yet been paid), deferred or unearned revenue (money collected from customers before the goods or service was delivered), and income taxes payable (taxes owed but not yet paid).
After the current liabilities, the liabilities section shows longer-term liabilities, including debt (due past 1 year), deferred tax liabilities (taxes in the figure are expected to be higher usually due to accelerated depreciation for IRS taxes), and other long-term liabilities (including underfunded pension liability).
The shareholder’s equity section shows the capital contributed by equity holders. The clearest case of that would be direct contributions by owners, including capital raises (initial public offerings or follow-on offerings). That can be reduced by share buybacks, which is when a company repurchases its own shares in the open market, subject to certain restrictions.
The second method owners contribute capital is by keeping the profits of the company in the business instead of distributing them. That is known as retained earnings, which is the lifetime net income (or loss) of the company minus the lifetime distributions the company has made.
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