Understanding the Balance Sheet : Accounting Basics for FP&A – Part 2

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Here is a quick recap of the Basic Accounting equation 

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Next, let’s take a closer look at the Balance Sheet

The Balance Sheet

The main purpose of the balance sheet is to report the financial position of an organization at a particular point in time.

It is a snapshot of the condition of the firm at the close of business on the last day of the financial year.

The most important use of the balance sheet is the information it provides on how the firm is financed, its asset structure and the distribution of that investment in current and fixed assets.

The basic format of the balance sheet is  

Assets = Liabilities + Equity

Assets are economic resources owned by a company. Examples of assets include cash, accounts receivable, supplies, building, machinery, and equipment etc.

Liabilities are the company’s debt or obligations. Examples of liabilities are accounts payable, unearned revenue and bonds payable.

Equity is the residual balance. Assets – Liabilities = Equity. Equity is commonly called shareholder’s equity. It represents the financing provided by the stockholders along with the earnings from the business not paid out as dividends.

There are 2 types of Assets    

   Current Assets

+ Non-Current Assets

= Total Assets

Current Assets are assets that will be used or turned in cash within one year. Examples include cash, accounts receivable, inventory, short term investments and supplies.

Non-Current Assets comprise the remainder of the assets. These include accounts such as long-term investments, land, buildings, equipment’s, patents etc.

There are 2 types of Liabilities

 Current Liabilities

+ Non-Current Liabilities

= Total Liabilities

Current Liabilities are obligations that will be paid in cash (or services) or satisfied by providing goods or services within the coming year. Examples include accounts payable, taxes payable etc.

Long Term Liabilities are obligations that will not be paid or satisfied within the next one year. Examples include mortgages payable and bonds payable.

Stockholders’ Equity is divided into two categories. Contributed capital and retained earnings.

  Contributed Capital

+ Retained Earnings

= Total Stockholders’ Equity

Contributed Capital is the amount of cash (or other assets) provided by the shareholders. Common Stock and additional paid in Capital are accounted in this section.

Retained Earnings is the total earnings that have not been distributed to owners as dividends.

Statement of Retained Earnings:

The statement of retained earnings reports how net income and dividends affected a company’s financial position during the period.

 Format of the Statement of Retained Earnings: 

Beginning Retained Earnings

+ Net Income for the year

– Dividends

Ending Retained Earnings

The Income statement must be prepared before the Statement of Retained earnings. This is because we need to know the Net Income for the year in order to compute the ending balance of retained earnings.

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The balance sheet must be prepared after the Statement of Retained Earnings in order to have calculated the ending balance of retained earnings.

Order of Preparation:

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As analysts and investors, we should keep in mind that some companies could “dress up” the balance sheet prior to reporting to shareholders.

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