Lesson 4: Balance Sheet

Lesson Overview 

In this lesson, you will:

Define balance sheet, and

Identify the components of a balance sheet.

What is a Balance Sheet? 

The Balance Sheet is a snapshot of your business. It outlines the financial condition of your business at a specific point in time. The balance sheet provides a financial perspective by highlighting what you own, and what you owe to other parties.

Current Assets vs. Fixed Assets 

Assets are what your business owns. They are bought to increase the business’ value and can generate cash flow.

Accountants like to categorize things, so we will describe two categories for assets: current assets and fixed assets.

Current Assets

In accounting terms, current assets are cash or other assets that can be converted into cash within one year. This includes accounts receivable, inventory, and prepaid expenses.

Fixed Assets

Fixed assets are property and equipment owned by your business—things not normally intended for sale, which are used repeatedly, such as buildings and machines.

Liabilities and Equity 

There are also two categories for the “what you owe to other parties’” section: liabilities and equity.

Liabilities

When you owe someone else, you could say that you are liable to that person or company. Therefore, we call these amounts liabilities. Liabilities are the company’s debts or obligations that arise during the course of business operations. Bank debt, loans, and accounts payable are examples of liabilities.

Equity

For the share of the business that you or other partners own, we’ll call this category, Owner’s Equity, which is the part of the assets that the owner or owners have claims to after all the liabilities are paid.

Sample Balance Sheet 

Here is a sample balance sheet. You will notice that it has broken down the assets using the two categories described earlier—current assets and fixed assets. It also includes the liabilities and equity categories.

Accounting Equation

Using the new accounting labels with what you know about your balance sheet scorecard, it should be easy to see that the assets always equal the liabilities plus equity.

This is called the “accounting equation.” It’s what makes your balance sheet always equal on both sides.

An important rule for accounting is that the left side will always equal the right side. If they don’t equal, then you have made a mistake. It is that simple.