• Balance Sheet

    The Balance Sheet contains the financial condition of a firm at a particular point of time. Here, the term ‘at a particular time’ is very important for its definition as it does not specify the condition over a period of time. If anyone wants to look at the financial condition at a particular time, he should check the balance sheet.  This includes the assets, liabilities, equity capital etc. Only the basic knowledge is provided for these types.

    Assets

    Assets are the combination of all the things that the firm owns, be it cash, property, Land, Machinery etc. The types are:

    Cash and Cash equivalent: Cash is the deposit in the bank accounts in a form of cash and Cash equivalents are the assets which can be converted into cash within a very short period of time. Cash equivalents include market share holdings, short term tradable government bonds, Treasure Bills, bank credits etc which can be converted into cash easily within a short period of time. Only thing is to sell them in market to get the cash. This is the most liquid form of asset. More cash and cash equivalents signifies more liquidity in the firm.

    Receivables: Receivables is the money the firm owed to the business from its different clients of customers, which the firm is expected to receive within that financial year. Suppose the firm has provided a service to a client of USD 100 and it is yet to receive the payment, then it will be termed as an asset under the receivable category.

    Inventory: Inventory is all the raw materials and goods the firm has in order to develop the final product or use by the business. For an auto manufacturing firm, the inventories can be different auto parts and steel plate to be used to manufacture new cars.

    Prepaid expenses: Prepaid expenses are the expenses that the firm has already incurred and paid to vendors but will receive the service in future. This is termed as asset as money has already been paid in advance for some service. Suppose a firm pays cost of its inventory in advance, then it will be termed as prepaid expenses until it receives the inventory from the supplier.

    Machinery, Land: Machinery and Land are also termed as the asset of the firm. The machinery and land have some market value and these are the assets to the firm. For machinery depreciation method is used to calculate its present value from the cost value, but for lands no depreciation method is used. Land is termed as non-depreciable asset. They are also termed as tangible assets.

    Intangible Assets: Intangible assets are monetary assets which can not be identified in physical terms. They are simply copy rights, patents, and trade marks etc which help the firm to create more business and generate more revenue. These are assets as they have some monetary value once to be sold in the market. Suppose a well known firm has a brand value which helps them to generate more revenue or a Pharma company owns a unique patent which helps it to develop a unique product to generate more revenue. These brand value and patent are intangible assets and have some monetary value.

    Deferred tax assets: Deferred tax asset is the tax money which is already paid more than the actual tax amount. As it is more than the actual tax amount, it will help to reduce the tax payment in future. That’s why it is termed as an asset. Suppose for a particular financial the actual tax is USD 1000 and the firm has paid the tax amount as USD 1200. Then the excess tax payment of USD 200 will be used as an asset under the deferred tax category.

    Current assets: Current assets are the assets which can be converted into cash within 12 months or one financial year. Cash and cash equivalents, Inventories, Receivables and prepaid expenses etc fall under the current asset category.

    Fixed Assets: Fixed assets are the asset which can not be converted into cash within 12 months or one financial year.

    Liabilities

    Liabilities are the obligations of the company over a period of time and it is related to cash outflow of the company in any form. As per the separate entity concept, profit is also a liability which has to be paid to the owners of the company.

    Liability can also be termed as the source of company’s assets. Suppose one creditor gives USD 100 loan to the firm to buy some machines. The machines bought with the money will be included in the fixed asset segment of Asset category with value of USD 100 and the same amount of money will be included in the loan segment of the Liabilities category as the money has to be paid back to the creditor and it is an obligation to the firm. With this double entry the asset will also match with the liabilities.

    The different examples of liabilities are specified below

    Payable

    Payables are the most important example of liabilities which denotes any obligations to the creditors, suppliers, employees, service providers etc. which has to be paid in future. The main point of payables is that the benefit has already been earned by the company in terms of revenue of developing the end product and the voucher or receipt is generate for the same but the payment has not yet been made. The payment has to be paid in future, either immediately of after some time.

    The different examples of payables are

    • Payables to creditors: If the company takes a loan from the bank then the loan amount will be included as a part of payable as this is an obligation of the company, which has to be paid in the future.
    • Salaries payables: The salary of the employees which is yet to be paid will come under payable section as it is an obligation to pay the salary as the company has used its workforce to generate revenue. Suppose any salary or arrears is pending at the end of financial period, then the pending salary/arrears amount will come under salaries payable section.
    • Interest Payables: Any Interest which is payable by the company to the creditors and lenders. It is also an obligation/expense of the company to pay the interest for the loan it has taken.
    • Income Tax Payables: Any pending income tax payment will fall under this category as well. Some Income tax payment can be carried forward from the previous quarter due to any miscalculation of earned revenue, which has to be paid next quarter.

    Accrued Expenses

    Accrued expenses denote the expenses which have been incurred as per the accrued accounting reporting but not yet paid by the company. This is mainly applicable to the periodic expenses like salaries, interest and taxes which have to be paid in future.

    We can use an example of periodic interest payment to understand the difference between normal accrued expenses and payable.

    Suppose a firm has taken a loan of 1000 USD from a bank with 10% interest rate, the interest rate has to be paid annually. So the annual interest payment will be 100 USD for the same loan. As per the accrued accounting principal, the firm will include the interest payment obligation of USD 25 as accrued interest expenses for each quarter rather than just including 100USD at the end of the year. This is how accrued expenses are included in the liability section of a firm.

    The difference between the accounts payable and accrued expenses is that for accounts payable, the invoice is generated and received by the firm. But for accrued expenses, it is just some adjusting accounting entries made at the end of each accounting period for accrued items like interest, salaries and taxes etc. The accrued expenses were not entered into the accounts because the invoice is not yet received, but all the account payable entries are entered into the final accounts.

    Pension Liabilities

    Pension liabilities denote the obligation of the company towards the pension and other retirement benefits of its employees. This liability provision enables the company to build the pension fund to cater the retirement benefit of all of its employees in future and here it is an obligation to its employees.

    Unearned revenue

    Unearned revenue denotes the revenue received for the services from the customers which are yet to be offered. It is an obligation of the company towards its customer. Suppose a sport stadium authority has sold some tickets of a cricket match which will be held after 3 months and earned some revenue out of it. This revenue will be termed as an unearned revenue as the match is yet to be played and it is an obligation of the stadium authority to provide the sitting service to the customers (ticket owners) on that particular date. Only after the match this unearned revenue will be termed as normal revenue.

    Deferred tax liabilities

    Deferred tax liability denotes any deferred tax which is to be paid in future. It helps the company to keep the provision for any future tax payment in the balance sheet.

    Owner’s Equity

    Owner’s equity denotes the owner’s residual claims on the firm’s resources which is same as the amount invested by the owners and all the shareholders. This is considered as the liability to the owners or the shareholders, which is the main reason it comes under the liability section of the balance sheet.

    Owner’s Equity = Assets – Liabilities

    Owner’s equity can be of different types

    Shares and Stock Capital

    Equity Capital

    Equity capital is the total amount paid by the owners and the shareholders to get the ownership in the company. Here “par value” denotes the legal or stated value of the stock. It is generally very low compared to the actual value of the stock. The Par value amount received from the shareholders is recorded in separate equity account. Total equity capital equals the par value of each share multiplied by the total number of shares.

    Paid in Capital

    Paid in capital is the amount which is paid in excess of par value to buy the shares in the Primary market. The shareholders pay this excess amount to get the shares of the company and this excess amount is determined by the valuation of the same.

    Contributed Capital

    Contributed Capital is the total amount paid by the shareholders to buy the shares of a company and it includes the equity or share capital and the additional paid in capital.

    Contributed Capital = Equity Capital + Additional paid in Capital

    For example, if a company issues 1000 shares at the issue price of USD 20 per share and the par value of each share is USD 10, then

    Total Equity Capital = USD (10*1000) = USD 10,000

    Additional Paid in Capital = USD (10*1000) = USD 10,000

    Total Contributed Capital = USD (10,000 + 10,000) = USD 20,000

    The equity shareholders are paid some percentage of profit in terms of dividends. The dividend percentage is calculated based on the par value. At the time of bonus issue, the par value remains same and for spilt the par value gets affected at the same ration of share split.

    Preference Shares

    Preference shares are issued to some preference shareholders with certain benefits and rights. Preference shareholders receive dividends regularly at pre-specified rate and they have higher priority claims over the common shareholders during the time of liquidation. As per the priority of claim during liquidation, the external creditors have the highest priority over the claims followed by preference shareholders and common shareholders.

    Common shareholders have the least priority over the claim, which is the main reason for equity investment being very risk and equity investors seek for more return out of their investment in common stock.

    Authorized Shares

    Authorized shares are the total number of shares that the Company is authorized to issues. It is determined at the time of preparation of articles of incorporation. Normally company prefers to have a large number of authorized shares so that it can issue shares in future easily whenever is needed to raise money from market or preference shareholders.

    Issued Shares

    Issued shares are the number of shares which were issued or sold to the shareholders. The shares are issued to raise money from the capital market, to acquire other companies or services, to reward the management for better performance or to gift the employees.

    Outstanding Shares

    Outstanding shares are the number of shares which are actually available in the market. If the company has not reacquired any issued shares then the number of outstanding shares will be same as the number of issued shares, else if the company has reacquired some shares (treasury stocks) then the number of outstanding shares will be less than the number of issued shares.

    Treasury Stocks

    Treasury stocks are the stocks which were bought back by the issuing company from the shareholders but not yet retired. These stocks stay with the issuing company and are not tradable in the capital market. It also reduces the shareholder’s equity.

    Company buys back its issued share mainly when it believes that the shares are undervalued in the market and whenever any acquisition threat by some other company. Sometimes company uses its profit percentage to buy back some issued shares from the market.

    Relationship among all types of shares

    Total Number of outstanding shares in the market ≤ Total Number of issued

    shares in the market ≤ Total Number of authorized shares a company can issue

    Another relationship between authorized and issued shares is

    Total Number of Issued Shares = Total Number of Outstanding Shares +

    Total Number of Treasury Stocks

    Retained Earnings

    Retained earnings are the total earnings left with the company throughout the years after its inception which were undistributed to the common shareholders or other preference shareholders. Every quarter the company earns some retained earnings from the undistributed profit which adds up to the total retained earnings with the company. Higher retained earnings denote higher cash reserve with the company. Sometimes company invests all the profit money for business expansion without paying them as dividend to the shareholders.

    Other Comprehensive Income

    Other comprehensive income denotes all the accumulated income from the changes in the shareholder’s equity value except for income statement transactions and any transactions with the shareholders.

    Balance Sheet Example

    Current assets denotes the cash, cash equivalents and the other assets which can be converted into cash or used within one year or one operating cycle whichever is greater. The operating cycle denotes the complete time taken to produce or purchase inventories, develop the end product, sell the products and collect the money from the debtors. Current assets provide the information and efficiency of the operating activities of the company and the short term cash inflow to the company

    Current liabilities denote the obligations of the company which have to be paid within one year or one operating cycle whichever is greater. Current liabilities include short term loans to be paid within one year, any interest, tax, pension, salary liabilities or any payment liability to the creditors to be paid within next year or one operating cycle. This specifies the short term cash outflow of the company.

    Working Capital is calculated as the difference between current assets and current liabilities. It specifies the current liquidity position of the company. Not enough working capital can lead to liquidity problem and may halt production process, at the same time too high working capital may lead to lose any other investment opportunity. Holding high cash reserves does not provide good return.

    Noncurrent assets denote the assets which cannot be converted into cash within one year or one operating cycle. Noncurrent assets are mainly land, building, plants, goodwill etc. which provide the information about the foundation of the company.

    Noncurrent liabilities are the liabilities which don’t need to be paid within next one year or one operating cycle. These are long term obligations of the company, mainly the long term loans or debts, long term corporate bonds with maturity date after one year. Long term liabilities mainly denote the funding source of the company.

    One sample Balance Sheet as on 31st March 2011 is shown below

    Balance Sheet as on 31st March 2011
    Liabilities Assets
    Current Liabilities USD  (Thousands) Current Assets USD (Thousands)
    Payables (A) 2000 Receivables (M) 450
    Interest Payable (B) 250 Cash and Cash equivalent (N) 2500
    Short term Loans (C ) 150 Inventory (O) 725
    Total Current Liabilities (D=A+B+C) 2400 Total Current Assets (P = M+N+O) 3675
       
    Non-Current Liabilities (K) Non-Current Assets (Q)
    Long Term Loans/Bonds (E) 2500 Land (R ) 7000
    Deferred tax liabilities (F) 125 Plant and Machinery (S) 5500
    Less Accumulated Depreciation (T) 1100
    Stockholders’ Equity Net Block (Net Value of Plant) (U = S – T) 4400
    Equity Share Capital (G) 8000 Good Will (V) 850
    Preference Share Capital (H) 800 Total Non-Current Assets (Q = R+U+V) 12250
    Reserves (I) 2100
     Total Noncurrent Liabilities (K=E+F+G+H+I) 13525
       
    Total Liabilities (D+K) 15925 Total Assets (P+Q) 15925

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