Ch2. The Balance Sheet — How to Read a Company Through Assets, Liabilities, and Equity

What Is a Balance Sheet?

Statement of Financial Position (Balance Sheet) A financial statement showing a company’s assets, liabilities, and equity at a specific point in time.

Assets = Liabilities + Equity
(What the company has) = (What it owes) + (What it owns)

Assets

Economic resources held by the company that are expected to bring future economic benefits.

Current Assets

Assets convertible to cash within one year.

Item	Description
Cash and Cash Equivalents	Immediately convertible to cash
Short-term Investments	Deposits and bonds maturing within 1 year
Accounts Receivable	Money owed from credit sales
Inventory	Goods, finished products, raw materials held for sale
Prepaid Expenses	Expenses paid in advance

Non-Current Assets

Long-term assets whose benefits are realized beyond one year.

Item	Description
Property, Plant & Equipment (PP&E)	Land, buildings, machinery (subject to depreciation)
Intangible Assets	Patents, goodwill, software
Long-term Investments	Long-term deposits, equity method investments
Deferred Tax Assets	Arising from temporary tax differences

Liabilities

Obligations a company owes to others. Items representing expected future outflows of economic resources.

Current Liabilities

Debts due within one year.

Item	Description
Accounts Payable	Money owed for credit purchases
Short-term Borrowings	Loans due within 1 year
Accrued Liabilities	Expenses incurred but not yet paid
Unearned Revenue	Revenue received before services are delivered

Non-Current Liabilities

Long-term debts due beyond one year.

Bonds Payable (Corporate Bonds)
Long-term Debt
Post-employment Benefit Obligations
Deferred Tax Liabilities

Equity (Stockholders’ Equity)

Net assets remaining after subtracting liabilities from assets. Represents shareholders’ claims.

Equity = Assets - Liabilities = Net Assets

Component	Description
Common Stock (Par Value)	Total par value of issued shares
Additional Paid-in Capital	Amount received above par value on stock issuance
Retained Earnings	Accumulated net income not yet distributed as dividends
Accumulated Other Comprehensive Income (AOCI)	Asset/liability revaluations and other items
Treasury Stock	Repurchased shares held by the company (contra equity)

Balance Sheet Analysis Ratios

Liquidity Analysis:

Current Ratio = Current Assets / Current Liabilities × 100%
(200% or above: healthy)

Quick Ratio = (Current Assets - Inventory) / Current Liabilities × 100%
(100% or above: healthy)

Solvency Analysis:

Debt-to-Equity Ratio = Total Liabilities / Equity × 100%
(100% or below: stable)

Equity Ratio = Equity / Total Assets × 100%
(50% or above: sound)

Key Concept Cards

Current vs. Non-Current Assets ★★★★★ : One year is the dividing line. Convertible to cash within 1 year = current asset; beyond 1 year = non-current asset. Memory tip: Current = within 1 year

Debt-to-Equity Ratio ★★★★★ : Measures reliance on external financing. Total Liabilities ÷ Equity × 100%. The higher it is, the greater the financial risk. Memory tip: D/E ratio of 100% = liabilities equal equity

Retained Earnings ★★★★☆ : Accumulated net income from all prior periods, minus dividends paid. The company’s internal reserves. Memory tip: Retained Earnings = All-time Net Income − All-time Dividends

Practice Quiz

Q. Where are a company’s accounts payable and accounts receivable each classified?

Accounts Receivable (money owed from selling on credit) → Current Asset. Accounts Payable (money owed for purchasing on credit) → Current Liability.

Q. Compare a company with a debt-to-equity ratio of 300% versus one with 50%.

300% means debt is three times equity → high financial leverage, greater risk of insolvency during a downturn. 50% means debt is half of equity → stable, but may be underutilizing investment capacity.

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