The balance sheet shows investors how much a company owns (its assets), how much it owes (its liabilities), and the difference between the two (its equity) at a specific point in time. So, you can think of the balance sheet as a snapshot of what a company is worth – according to accounting rules – on a given day. The Income Statement shows revenue and expenses from 1st Jan 20XX to 31st Dec 20XX, but the Balance Sheet only shows the company’s resources on 1st Jan 20XX or on 31st Dec 20XX.
The Accounting Equation
One of the most important things to know about the balance sheet is that it must always balance. Total assets always equal total liabilities plus total equity. So, if a company’s assets increase from one period to the next, you can be sure that the company’s liabilities and equity have also increased by the same amount.
If you want a house – an asset – that costs $1 million, could you pay for it with a $380,000 mortgage and $200,000 in saving? No, the Balance Sheet would be out of balance. You would have to borrow or save more. So, you either take out an $800,000 mortgage or wait and save another $620,000.
Assets are things that a company owns that have value which are expected to provide future benefits. This usually means that they can either be sold or used by the company to make products or provide services that can be sold. Assets include physical property such as plants, trucks, equipment, and inventory. They also include things you can’t touch but still exist and have value, such as trademarks and patents. And cash itself is an asset. The same applies to investments that a company makes. To qualify as an asset, the following requirements must be met:
- A company must own the resource
- The resource must be of value
- The resource must have a quantifiable, measurable cost
Liabilities & Equity
Liabilities and Equity represent the company’s sources of funds (how it pays for assets).
Liabilities are amounts of money that a company owes to others. They can include all kinds of obligations, such as money borrowed from a bank to launch a new product, rent for the use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future. To qualify as a liability, the following requirements must be met:
- They must be measurable
- Their occurrence is probable
Equity or Shareholders’ Equity is sometimes called capital or net worth. It is the money that would be left over if a company sold all its assets and paid off all its liabilities. This leftover money belongs to the shareholders or owners of the company.
Here is sample of a Balance Sheet (Pepsico Annual Report 2021):