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The Balance Sheet is the financial report that shows what the business is worth at some instant in time.  This lesson will focus on the Asset side of the Balance Sheet.

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Quick reference

Balance Sheet Part 2

The Balance Sheet is the financial report that shows what the business is worth at some instant in time.  This module will focus on the Asset side of the Balance Sheet.

When to Use Balance Sheets

The Balance Sheet is normally calculated whenever financial reports are prepared and submitted to investors or senior management.  It is useful for tracking liquidity and debt.

Instructions

  • Unlike the other major financial reports, the Balance Sheet is for an instant in time, not a period of time.
  • The Balance Sheet shows what the company has as assets and what the company owes as liabilities – the difference is the owner’s equity or the net worth of the company. 
  • The Balance Sheet indicates what types of assets the company has – cash, inventory, buildings, equipment, etc.
  • Assets are used by operational managers to conduct the work of the business.  They are used in business processes.
  • Assets can be bought and sold.
  • Current Assets are those which are cash or theoretically can be quickly converted to cash:
    • Cash
    • Stocks, bonds and securities
    • Accounts Receivable – in businesses using the accrual accounting method, this is money that is owed to the business for products or services that have already been recorded as sales – “The check is in the mail.”  This is a current asset because it is expected that the customer will pay soon.
    • Inventory – this is inventory of items that are to be sold to customers.  It can be in any stage of production from incoming receiving to finished goods in the warehouse.  This is a current asset because it is expected that a buyer can be quickly found for inventory.
  • Fixed Assets are those that normally cannot be quickly converted to cash.
  • Fixed Assets are investments by the business and the cost of the asset must be recorded and tracked in a special manner known as capitalization and depreciation.  These will be covered in other modules.
  • Depreciation is recorded on the Balance Sheet as a reduction in the value of a Fixed Asset.  It represents the concept that the asset is “used up” or “worn out” over time and therefore loses value.
  • An unusual category of Fixed Assets that will sometime be found on a Balance Sheet is Goodwill.  This normally occurs when a company has bought another company.  Often the price paid is not exactly the same as the equity value on the Balance Sheet.  However, when buying a company the purchased company’s Balance Sheet is incorporated into the purchaser’s Balance Sheet.  Since the purchaser paid more than the Balance Sheet said it was worth, the extra value is called Goodwill, treated as a Fixed Asset and then depreciated like other Fixed Assets.
  • Fixed Asset categories are normally:
    • Land and real estate
    • Buildings and building improvements (not building maintenance)
    • Capital equipment – which is equipment used in business processes such as IT equipment or manufacturing equipment.  The equipment could be fixed in one location like an five-axis milling machine, or it could be used for transportation, like a fleet of trucks.

 

Hints and Tips

  • The value used for each category is normally pulled from the accounts in the company’s financial system.
  • Many companies will subdivide some of the Balance Sheet accounts to show specific categories of assets.
    • For example: a company with a financing division to support the product division may show the Accounts Receivables for financing separately from the product because of the different risk profile.
  • The value for Fixed Assets is normally based upon the purchase price of the asset, not the current market value.
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  • 00:04 Hi, this is Ray Sheen.
  • 00:05 Let's dig deeper on the balance sheet.
  • 00:07 This is part 2 on this topic, and we'll focus this one on assets.
  • 00:12 Assets are the left side of the balance sheet.
  • 00:16 Assets are the company resources used to generate income and cash flow.
  • 00:21 These are the things that the business owns.
  • 00:23 Assets are buildings and equipments.
  • 00:25 Assets are material and products.
  • 00:26 There are also financial assets, such as cash and
  • 00:29 accounts containing financial instruments.
  • 00:32 Assets are used by the business operations managers
  • 00:35 to conduct the work of the business.
  • 00:37 The assets are applied to the business processes in order to make products,
  • 00:40 deliver services and create value.
  • 00:43 One other point, assets can be bought and sold.
  • 00:46 There's a title or some way to identify the asset specifically.
  • 00:50 That asset has intrinsic value and
  • 00:52 can be sold to generate increased revenue if needed.
  • 00:56 Looking at the balance sheet, you can see that there are two broad categories,
  • 01:00 current assets and fixed assets.
  • 01:02 Let's look at each.
  • 01:03 First, the current assets, and let's start with what makes them current.
  • 01:08 Current assets are those that either are cash or can be easily converted to cash.
  • 01:13 Cash has immediate value.
  • 01:15 It is always current.
  • 01:17 The next current asset category is stocks, bonds and
  • 01:20 securities that are held by the company.
  • 01:22 Normally, these are as good as cash,
  • 01:24 because there's a ready market where we can sell them.
  • 01:27 Just a quick aside, banks and
  • 01:29 financial institutions have to be careful about the selling of securities.
  • 01:33 If they dump a large number, it can cause upheaval in the stock market.
  • 01:37 So in some cases, and for some businesses, securities are not really current assets.
  • 01:42 The third category of current assets is accounts receivable.
  • 01:46 This category only applies to companies that use the accrual basis for accounting.
  • 01:50 You should recall that in the accrual basis, a company sells a product or
  • 01:54 service, and sends an invoice.
  • 01:56 That is immediately recorded as a sales on the earning statement.
  • 01:59 However, the customer may not pay the invoice for another 30 or more days.
  • 02:04 These unpaid invoices are tracked in the account called accounts receivable,
  • 02:08 because the company expects to receive that money soon.
  • 02:12 Since the transactions in the account will turn to cash soon,
  • 02:15 typically 30 days, these are also considered current asserts.
  • 02:19 This can be a very large number.
  • 02:22 If your business has 30 day terms,
  • 02:24 it will represent one-twelfth of the annual revenue.
  • 02:27 If 60 day terms, it will be one-sixth of the annual revenue.
  • 02:32 The final category of current assets is inventories.
  • 02:35 This is raw material and product inventory,
  • 02:38 meaning it is the value of inventories that is intended to be sold to customers.
  • 02:42 Inventory is a current asset because it is assumed that there are ready
  • 02:45 customers who will buy that inventory.
  • 02:48 I know that it isn't always a valid assumption, but it is generally true for
  • 02:52 most companies, and that is how the accounting standards are set up.
  • 02:57 Now let's take a look at the other category of assets, fixed assets.
  • 03:01 Fixed assets are considered to be more permanent than current assets.
  • 03:04 They're not as easy to turn into cash, and
  • 03:07 we're not selling them off as part of normal business operations.
  • 03:11 I know, some fixed assets are easier to sell than some inventory.
  • 03:14 However, it is not a judgment call by us.
  • 03:17 These categories are based upon rules set by the accounting standards.
  • 03:21 Fixed assets are considered to be an investment.
  • 03:24 The business has spent money to obtain something that they believe
  • 03:27 will help them make money in the future.
  • 03:29 Because it is money spent now with a promise of making money in the future,
  • 03:33 it is accounted for differently on the earning statement.
  • 03:36 However, on the balance sheet,
  • 03:37 we record the full amount as soon as we receive the asset.
  • 03:41 The typical categories of fixed assets are land, buildings, and equipment.
  • 03:45 Land is pretty easy to understand.
  • 03:47 Buildings include both of cost of the building and any building improvements and
  • 03:51 upgrades, but not basic building maintenance.
  • 03:54 Equipment is a very broad category.
  • 03:57 It includes manufacturing equipment, test equipment used in the factory or
  • 04:00 in the field on service calls.
  • 04:02 It includes trucks, cars,
  • 04:03 and company-owned equipment to help people do their job.
  • 04:07 It includes IT equipment, security systems, and other high-tech equipment.
  • 04:11 One more thing about most of that equipment and
  • 04:13 the buildings, they wear out over time.
  • 04:16 Their value is used up.
  • 04:18 They were recorded on the balance sheet at their original purchase price, or
  • 04:22 the cost of development.
  • 04:23 But over time, their value has diminished.
  • 04:26 This loss of value is reflected in the term depreciation.
  • 04:29 We will devote an entire module to this term and concept.
  • 04:34 Okay, that is the asset side of the balance sheet.
  • 04:38 It helps us understand what the business has control of.
  • 04:41 Now, in the next module, we'll look at the other side of the balance sheet.

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