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Intro to Business
Table of Contents
Unit 14 Overview: Financial Information & Accounting Basics
14.1 Accounting: More than Numbers
14.2 The Accounting Profession
14.3 Basic Accounting Procedures
14.4 The Balance Sheet
14.5 The Income Statement
14.6 The Statement of Cash Flows
14.7 Analyzing Financial Statements
14.8 Trends in Accounting

The balance sheet is a crucial financial statement that shows a company's assets, liabilities, and equity at a specific point in time. It provides a snapshot of a business's financial health, revealing what it owns and owes.

Understanding the balance sheet is essential for assessing a company's financial position. It helps investors, creditors, and managers make informed decisions by analyzing the firm's liquidity, solvency, and overall financial structure.

The Balance Sheet

Purpose and Components

  • Balance sheet provides snapshot of company's financial position at specific point in time, showing what it owns (assets) and owes (liabilities and owners' equity)
  • Assets are resources owned by company with economic value, including current assets (cash, accounts receivable, inventory), fixed assets (land, buildings, equipment), and intangible assets (patents, trademarks, goodwill)
  • Liabilities are debts and obligations owed by company, consisting of current liabilities due within one year (accounts payable, short-term loans) and long-term liabilities due beyond one year (bonds payable, long-term loans)
  • Owners' equity is residual interest in assets after deducting liabilities, including contributed capital invested by owners (common stock, additional paid-in capital) and retained earnings from cumulative net income not distributed to owners
  • Fundamental accounting equation: Assets = Liabilities + Owners' Equity, ensuring balance sheet always balances

Asset Types

  • Current assets are cash and other assets expected to convert to cash within one year or operating cycle, such as accounts receivable (money owed by customers), inventory (goods held for sale), short-term investments (marketable securities), and prepaid expenses (rent, insurance)
  • Fixed assets, also known as property, plant, and equipment, are tangible assets used in business operations with useful life over one year, including land, buildings, machinery, equipment (computers, vehicles), subject to depreciation to allocate cost over useful life
  • Intangible assets are non-physical assets providing long-term benefits, such as patents (exclusive rights to inventions), trademarks (distinctive symbols or names), copyrights (original works), goodwill (excess purchase price over fair value), brand recognition, subject to amortization to allocate cost over useful life

Liabilities and Equity

  • Current liabilities are obligations expected to be paid within one year or operating cycle, including accounts payable (money owed to suppliers), short-term loans (bank borrowings), accrued expenses (salaries, interest), and unearned revenue (advance payments from customers)
  • Long-term liabilities are obligations not due within one year or operating cycle, such as bonds payable (debt securities issued to investors), long-term loans (mortgage, vehicle financing), and deferred tax liabilities (taxes owed in future)
  • Owners' equity represents owners' residual interest in company's assets after deducting liabilities, consisting of:
    1. Contributed capital: Amount invested by owners, including common stock (ownership shares) and additional paid-in capital (excess over par value)
    2. Retained earnings: Cumulative net income earned by company not distributed to owners, increasing with profits and decreasing with losses and dividends paid

Key Terms to Review (63)

Debt-to-equity ratio: The debt-to-equity ratio is a financial metric that compares a company's total liabilities to its shareholder equity, indicating the balance between debt financing and equity financing used by a company. It provides insight into how much of the company is financed by debt compared to what is financed by investors' equity.
Balance sheet: A balance sheet is a financial statement that provides a snapshot of a company's financial condition at a specific point in time, detailing its assets, liabilities, and shareholders' equity. It is essential for assessing the company's liquidity, solvency, and overall financial health.
Inventory: Inventory encompasses all the goods and materials a business holds for the purpose of resale, use in production, or other operational purposes. It is a crucial component of supply chain management, ensuring that products are available to meet customer demand without excessive surplus.
Liquidity: Liquidity measures how quickly and easily an asset can be converted into cash without significantly affecting its value. In the context of a balance sheet, it indicates a company's ability to meet short-term obligations with its most liquid assets.
Retained earnings: Retained earnings are the portion of a company's profits not distributed to shareholders as dividends but kept in the company to reinvest in its core business or to pay off debt. They are found under shareholders' equity on the balance sheet.
Export Working Capital Program: The Export Working Capital Program is a government-backed initiative designed to provide short-term working capital to exporters. It assists companies in financing the entire export cycle, from purchasing raw materials to shipping finished products.
Current liabilities: Current liabilities are financial obligations that a company is expected to pay within one year or within its normal operating cycle, whichever is longer. These include debts such as accounts payable, short-term loans, and accrued expenses.
Current ratio: The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year with its current assets. It is calculated by dividing the total current assets by the total current liabilities.
Generally accepted accounting principles (GAAP): GAAP consists of a common set of accounting rules and standards used in the United States for preparing financial statements. These principles ensure consistency, clarity, and comparability of financial information across different organizations.
Long-term liabilities: Long-term liabilities are financial obligations of a business that are due more than one year in the future. These include loans, mortgage payments, or bonds payable that do not require settlement within the next 12 months.
Fixed assets: Fixed assets are long-term tangible assets that a company owns and uses in its operations to generate income. These assets are not expected to be converted into cash within a year and include items like property, plant, and equipment (PP&E).
Intangible assets: Intangible assets are non-physical assets that have value due to the rights or information they provide to a business. They include intellectual property, brand names, and software.
Current assets: Current assets are all the assets a company expects to convert into cash or use up within one year or within its operating cycle, whichever is longer. They include items such as cash, inventory, and accounts receivable.
Accounts receivable: Accounts receivable is the total amount of money owed to a company by its customers for goods or services that have been delivered or used but not yet paid for. It is considered a current asset on a company's balance sheet.
Patents: A patent is a legal right granted to an inventor that prevents others from making, using, or selling the inventor's creation without permission. Patents protect innovative ideas and inventions, providing the inventor with exclusive rights to their creation for a limited period of time.
Trademarks: A trademark is a distinctive sign, design, or expression that identifies a product or service and distinguishes it from those of other providers. Trademarks are an important part of a company's intellectual property and branding strategy, as they help consumers recognize and remember a particular product or service.
Depreciation: Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. It represents the gradual decrease in the value of an asset due to usage, time, or obsolescence. Depreciation is a critical concept in understanding financial statements and the overall financial health of a business.
Working Capital: Working capital is the difference between a company's current assets and current liabilities, representing the liquid resources available to fund day-to-day business operations. It is a crucial metric that reflects a company's short-term financial health and ability to meet its immediate obligations.
Equity: Equity refers to the ownership interest in a business or asset, representing the residual value after all liabilities have been paid. It is the difference between a company's total assets and its total liabilities, and it reflects the net worth of the business from the perspective of its owners or shareholders.
Inventory: Inventory refers to the stock of goods or materials that a business holds for the purpose of resale or use in the production of goods. It is a critical component of a company's assets and plays a vital role in the distribution, accounting, and financial reporting processes.
Balance Sheet: The balance sheet is a financial statement that provides a snapshot of a company's assets, liabilities, and equity at a specific point in time. It serves as a fundamental tool for understanding a business's financial position and is a crucial component of the overall financial reporting process.
Assets: Assets are resources owned or controlled by a business that have monetary value and are expected to provide future economic benefits. They are essential components of a company's balance sheet, representing the valuable items the business possesses and can utilize to generate revenue and growth.
Liabilities: Liabilities are the financial obligations or debts that a company or individual owes to others. They represent the claims that creditors have on the company's assets and must be paid off or settled over time.
Wages Payable: Wages payable refers to the liability account on a company's balance sheet that represents the total amount of unpaid wages owed to employees for work performed. It represents the company's obligation to pay its employees for services rendered during the current accounting period but not yet paid as of the balance sheet date.
Owners' Equity: Owners' Equity, also known as shareholders' equity or net worth, represents the residual claim on the assets of a business after all liabilities have been paid. It is the amount of the business that belongs to the owners or shareholders.
Copyrights: Copyrights are legal rights granted to the creator of an original work, such as a book, song, painting, or computer program, which provide the exclusive right to reproduce, distribute, display, perform, or make derivative versions of that work for a limited period of time. Copyrights are a crucial aspect of the balance sheet, as they represent an intangible asset that can hold significant value for a company.
Unearned Revenue: Unearned revenue, also known as deferred revenue, refers to payments received by a company for goods or services that have not yet been delivered or performed. It represents a liability on the company's balance sheet, as the company has an obligation to provide the promised goods or services in the future.
Accrual Accounting: Accrual accounting is a method of accounting that recognizes revenue when it is earned and expenses when they are incurred, regardless of when the actual cash transactions occur. This approach provides a more accurate representation of a company's financial position and performance compared to cash-based accounting.
Accounts Receivable: Accounts receivable refers to the money owed to a business by its customers for goods or services provided on credit. It represents the short-term, uncollected revenue that a company has earned but not yet received payment for, and it is an important component of a company's working capital and overall financial health.
Accounts Payable: Accounts payable refers to the short-term obligations or debts a business owes to its suppliers or vendors for goods and services purchased on credit. It represents the amount a company owes to its creditors and is a crucial component of the balance sheet.
Retained Earnings: Retained earnings represent the portion of a company's net income that is retained or saved rather than distributed to shareholders as dividends. It is an important component of a company's balance sheet, reflecting the accumulation of its past profits over time.
Accrued Expenses: Accrued expenses are liabilities that have been incurred but not yet paid for by a company. These are expenses that have been recognized in the accounting records but for which no invoice has been received or payment made. Accrued expenses are a crucial concept in the context of basic accounting procedures and the balance sheet.
Current Ratio: The current ratio is a financial metric that measures a company's ability to pay its short-term obligations using its current assets. It is a key indicator of a company's liquidity and financial health.
Long-Term Debt: Long-term debt refers to financial obligations that a company or individual has to repay over a period longer than one year. These are typically loans or bonds with maturity dates extending beyond the current fiscal year, used to finance long-term investments or operations.
Book Value: Book value is the value of an asset as it appears on a company's balance sheet. It represents the original cost of the asset minus any accumulated depreciation or impairment charges. Book value is an important concept in the context of a company's balance sheet, as it provides insight into the true worth of a company's assets.
GAAP: GAAP, or Generally Accepted Accounting Principles, is a set of standardized guidelines and rules that govern the recording and reporting of financial transactions and the preparation of financial statements. GAAP ensures consistency, comparability, and transparency in financial reporting across organizations, industries, and countries.
Intangible Items: Intangible items are assets that have no physical form but hold value for a business. These are non-physical resources that provide economic benefits, such as intellectual property, goodwill, and brand recognition. Intangible items are an important consideration in the context of a company's balance sheet, as they can significantly impact its overall financial position and valuation.
Pension Obligations: Pension obligations refer to the financial commitments an employer has to its current and former employees for their retirement benefits. These obligations represent the present value of future pension payments that the employer is legally or contractually required to make to its employees upon retirement.
Accounting Equation: The accounting equation is a fundamental principle in accounting that establishes the relationship between a company's assets, liabilities, and owner's equity. It is the foundation for the balance sheet, one of the primary financial statements used to report a company's financial position.
Prepaid Expenses: Prepaid expenses are costs that have been paid in advance for goods or services that have not yet been consumed or used. These expenses are recorded as assets on a company's balance sheet until the benefits are realized, at which point they are recognized as expenses on the income statement.
Current Assets: Current assets are cash and other assets that are reasonably expected to be converted into cash or consumed within one year or the normal operating cycle of a business, whichever is longer. They are essential components of a company's balance sheet and provide a snapshot of its short-term financial health and liquidity.
Bonds Payable: Bonds payable are a type of long-term debt instrument issued by a company to raise funds from investors. They represent the company's obligation to repay the borrowed amount, plus interest, over a specified period of time. Bonds payable are an important component of a company's balance sheet, as they provide insight into its financing structure and debt management strategies.
Non-Current Assets: Non-current assets, also known as long-term assets, are assets that are not expected to be converted into cash or consumed within one year of a company's reporting period. These assets are held by a business for long-term use or investment purposes and are essential for the ongoing operations and growth of the organization.
Going Concern Concept: The going concern concept is a fundamental accounting principle that assumes a business will continue to operate indefinitely, rather than being forced to liquidate or materially curtail its operations. This concept is crucial in the preparation and presentation of a company's balance sheet, as it affects the valuation and classification of assets and liabilities.
Shareholder's Equity: Shareholder's equity, also known as stockholder's equity, represents the residual interest in a company's assets after deducting its liabilities. It is the value of a company's assets that would be returned to shareholders if all of the company's debts were paid off and the company was liquidated.
FASB: FASB, or the Financial Accounting Standards Board, is the independent, private-sector organization responsible for establishing and improving financial accounting and reporting standards in the United States. It plays a crucial role in the context of the balance sheet, as it sets the guidelines and principles for how companies should record, classify, and report their assets, liabilities, and equity on this key financial statement.
Goodwill: Goodwill is an intangible asset that represents the value of a company's reputation, customer relationships, and other non-physical factors that contribute to its earning power. It is the amount paid by a buyer in excess of the fair market value of a company's net assets during an acquisition.
Contributed Capital: Contributed capital, also known as paid-in capital, refers to the amount of money or other assets that shareholders or owners have invested in a business. It represents the funds that have been contributed to the company by its owners or investors, and it is a critical component of a company's balance sheet.
Current Liabilities: Current liabilities are short-term financial obligations that a company is expected to pay within one year or the normal operating cycle, whichever is shorter. These liabilities represent debts or payments that must be made in the near future, and they are an important component of a company's balance sheet.
Financial Statement: A financial statement is a formal record of a company's financial activities and position, including its assets, liabilities, income, and cash flows. These statements provide a comprehensive overview of a business's financial health and performance over a specific period of time.
Tangible Items: Tangible items refer to physical, touchable assets that have a measurable monetary value and can be included on a company's balance sheet. These are the concrete, material resources that a business owns and can be used in its operations or converted into cash.
Net Worth: Net worth is a financial metric that represents the total value of an individual's or a company's assets minus their total liabilities. It is a measure of a person's or entity's overall financial health and is often used to assess their financial standing and ability to meet financial obligations.
Liquidity: Liquidity refers to the ease and speed with which an asset can be converted into cash without significant loss in value. It is a crucial concept in finance and accounting, as it measures a company's or individual's ability to meet short-term obligations and maintain financial flexibility.
Lease Obligations: Lease obligations refer to the contractual responsibilities and financial commitments that a lessee (tenant) takes on when entering into a lease agreement for the use of an asset, such as real estate or equipment. These obligations outline the lessee's duties and the terms under which the leased asset must be used and maintained during the lease period.
Historical Cost Principle: The historical cost principle is an accounting concept that requires assets and liabilities to be recorded on a company's balance sheet at their original cost, rather than their current market value. This principle ensures that financial statements provide a reliable and verifiable record of a company's transactions and financial position over time.
Property: Property refers to the assets and resources owned by an individual or organization, which have monetary value and can be used to generate income or provide economic benefits. It encompasses both tangible and intangible assets that are legally recognized and can be bought, sold, or exchanged.
Deferred Tax Liabilities: Deferred tax liabilities are a type of liability on a company's balance sheet that represent the amount of income taxes owed for the current period but not yet paid. They arise when there are differences between the accounting and tax treatment of certain transactions, resulting in a higher tax liability in the future.
Debt-to-Equity Ratio: The debt-to-equity ratio is a financial metric that measures a company's leverage by comparing its total liabilities to its shareholders' equity. It provides insight into a company's capital structure and financial health, indicating the extent to which the business is funded by debt versus equity.
Cash Equivalents: Cash equivalents are highly liquid, short-term investments that can be readily converted into known amounts of cash and have a maturity of three months or less from the date of acquisition. They are considered a part of a company's cash management and are included in the cash balance on the balance sheet.
Plant and Equipment: Plant and equipment, also known as property, plant, and equipment (PP&E), refer to the tangible long-term assets that a business owns and uses in its operations. These assets are expected to provide economic benefits to the business for more than one year and are essential for the company to generate revenue and carry out its day-to-day activities.
Solvency: Solvency refers to a company's ability to meet its long-term financial obligations and maintain a stable financial position. It is a measure of a firm's overall financial health and its capacity to continue operating and servicing its debt in the foreseeable future.
Fiscal Year: A fiscal year is a 12-month period used for financial reporting and budgeting purposes, which may or may not align with the calendar year. It is the period of time a company or organization uses to calculate its annual financial statements and report its financial performance.
Amortization: Amortization is the process of allocating the cost of an intangible asset, such as a loan or a lease, over its useful life. It is an accounting method used to gradually reduce the value of an asset on the balance sheet over time, typically through periodic payments or charges to the income statement.