Balance Sheet Basics and the Accounting Equation

By | September 16, 2020

balance sheets for dummies

Hence it is important to read the details of how they carry their inventory. According to the balance sheet notes, the inventory is carried at the lower of cost and net realizable value (NRV). Many of the financial instruments that contribute to other income are not listed on the balance sheet.

His business, PM Financial Services, has helped people with financial and business concerns since 1981. He is the author of Stock Investing For Dummies (Wiley) and has accurately forecast many economic events, such as the rise of gold, the decline of the U.S. dollar, and the housing crisis. Andrew Bell was an investment reporter and editor with The Globe and Mail for 12 years.

Balance sheet equation

To do this, you will need to know your company’s current ratio and days cash on hand. Because it summarizes a business’s finances, the balance sheet is also balance sheets for dummies sometimes called the statement of financial position. Companies usually prepare one at the end of a reporting period, such as a month, quarter, or year.

You can use this report to see how your business is doing overall and whether it has enough cash to cover its expenses. When creating a balance sheet, start with two sections to make sure everything is matching up correctly. On the other side, you’ll put the company’s liabilities and shareholder equity. While it can give a great deal of insight into the financial health of your organization, a balance sheet can’t reveal everything.

How Balance Sheets Work

Depending on the company, the exact makeup of the inventory account will differ. For example, a manufacturing firm will carry a large number of raw materials, while a retail firm carries none. The makeup of a retailer’s inventory typically consists of goods purchased from manufacturers and wholesalers. If you are a shareholder of a company or a potential investor, it is important to understand how the balance sheet is structured, how to read one, and the basics of how to analyze it. Paul Mladjenovic, CFP is a certified financial planner practitioner, writer, and public speaker.

This register serves as a comprehensive record, detailing all the information about each asset owned by your business. Not only does it help in tracking the value and condition of your assets over time, but it also plays a vital role in financial management, ensuring accurate depreciation calculations. The three financial statements are the Balance Sheet, the Profit and Loss Statement, and the Cash Flow Statement. A business owner may review a balance sheet to help determine if the company is succeeding.

The Purpose of the Balance Sheet

Toggl’s balance sheet template gives an overview of your balances in one single view. It also has pre-set items for current assets, fixed assets, current liabilities, and long-term liabilities so, you won’t have to add them in yourself. A balance sheet is important because it shows business owners and investors what a company owns and owes during a specific period. A balance sheet for a typical accounting period (12 months) would reflect the number of assets and liabilities when the period ends. The current ratio measures the liquidity of your company—how much of it can be converted to cash, and used to pay down liabilities.

balance sheets for dummies

Total equity is calculated as the sum of net income, retained earnings, owner contributions, and share of stock issued. That’s because a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholder equity). As you can see from the balance sheet above, Walmart had a large cash position of $14.76 billion in 2022, and inventories valued at over $56.5 billion.

Compare total assets against liability and equity.

Goodwill is checked for impairment every year and is written-off when it is no longer valuable. Details about the value of goodwill and its components are listed in the notes to the balance sheet. Since goodwill impairment is a value judgment, it is important to read the goodwill with notes section of the balance sheet. For new companies, a higher debt-to-equity ratio may be common if it’s relying on a bank loan or other financing to get the business up and running.