Keeping your business operations healthy is no walk in the park. It takes a keen eye and a general understanding of accounting practices and financial statements, even if your business is relatively small. There are several bookkeeping basics you should be familiar with—things like income statements, break-even analysis and your balance sheet.
A balance sheet is an essential financial statement.It includes a high-level view of your assets, liabilities, and shareholder’s equity. When filling out your balance sheet, you’ll need a clear understanding of assets, liabilities and shareholder equity.
And you’ll need to know which category cash falls under.
Today we’re going to look at your business’s balance sheet. We’ll go over how a balance sheet is structured, what’s included in each section, and some examples you can use to relate to your business.
So is cash an asset? Let’s find out.
Is cash an asset?
In short, yes—cash is a current asset and is the first line-item on a company’s balance sheet. Cash is the most liquid type of asset and can be used to easily purchase other assets.
Liquidity is the ease with which an asset can be converted into cash. Cash is the universal measuring stick of liquidity. It’s the easiest form of value that is used to purchase other products, services or assets.
In comparison, illiquid assets cannot be converted to cash as easily. Illiquid assets might include a piece of machinery, property or supplies. While these assets still hold value, they must be sold and converted into cash before they can be transferred into other assets.
It’s no wonder the term “cash is king” rings so true.
In short, yes—cash is a current asset and is the first line-item on a company’s balance sheet. Cash is the most liquid type of asset.
Structure of the balance sheet
Most companies organize their balance sheet in a vertically-formatted report. The balance sheet is organized into three categories—assets, liabilities and equity—and includes five types of account entries.
Balance sheets are used to document the financial well-being of a company. They take into account what a company owns, what it owes other companies or creditors, and the ownership stake investors have in the company.
The contents of a balance sheet can be summarized using this simple equation:
Assets = Liabilities + Equity
An asset is a resource or something of value that a company owns. Assets can be used to create further value for the company either currently or in the future.
A liability is an obligation that a company owes. This could be money owed to suppliers, tax obligations or business loans.
Equity refers to what a company owes its shareholders. You can calculate shareholder equity by simply subtracting liabilities from assets.
The balance sheet is then broken down into five different categories with the most liquid assets being at the top of the report.
- Current assets
- Fixed assets
- Short-term liabilities
- Long-term liabilities
- Shareholder’s equity
Let’s walk through each of these more thoroughly. We’ll also give some examples to better explain.
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Current assets vs. fixed assets
Current assets can be converted to cash more easily while fixed assets are more anchored and can’t be quickly sold for cash. This makes current assets more liquid than fixed assets.
A general rule of thumb is that a current asset can or will be used within one year and a fixed asset can’t or won’t be converted to cash within a one-year period. The balance sheet addresses current assets before getting into fixed assets.
Let’s take a look at current assets first.
What is a current asset?
Current assets are those which will be used, consumed or spent within a year. They are what a company uses to operate the business and carry out functions on a day-to-day basis.
- Cash: Money in its purest form that can be used to purchase anything to drive the business forward
- Cash equivalents: Short-term investments—including treasury bills, commercial paper, marketable securities, money market funds and short-term government bonds—that are nearly the same as cash
- Accounts receivable: What is owed to the company for selling goods and services but has yet to be paid
- Inventory: Raw materials and finished products intended to be sold in the near future
- Prepaid expenses: Things a company has already paid for and is planning on receiving in the near future
Depending on what type of company you operate, you can put all types of assets in this section, like your cash on hand, money your customers owe you, and the materials you use to operate your business on a daily basis. You may not have any fixed assets.
So how are fixed assets different from current assets?
What is a fixed asset?
Fixed assets are illiquid and aren’t intended to be converted into cash within a year. Fixed assets tend to be more tangible items that a company holds long-term.
These types of assets are physical in nature and can also be called tangible assets, long-term assets or capital assets. Here are a few examples of what are considered fixed assets.
- Property: Land or real estate that a company owns
- Plant: Factories, offices, restaurants and other types of buildings
- Equipment: Office equipment, machinery, furniture, vehicles, computers or other tools used for providing goods and services
Fixed assets like equipment and machinery will lose value over time. To counter this loss of valuation, companies will depreciate the value of certain fixed assets over a set period of time.
For example, if you buy a computer today, in five years that very same computer will be worth much less. You won’t be able to sell it for the same price you bought it for.
Now let’s move to the next two sections of the balance sheet: liabilities and shareholder’s equity.
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Liabilities and shareholder’s equity
Liabilities and equity are what balance out the appropriately named balance sheet.
In short, liabilities are what a company owes and shareholder’s equity is what it would owe to owners if it were to liquidate all assets and pay off debts.
What are liabilities?
Liabilities are what a company owes to other companies, creditors, the government or its employees. These are financial obligations that must be paid. Think of them as the costs of doing business.
A company has short-term and long-term liabilities. The short-term liabilities, also called current liabilities, consist of what must be paid within the next year. Long-term liabilities, or non-current liabilities, are what a company is responsible for paying for after one year.
Here are some examples of the liabilities you’d find on your balance sheet.
- Accounts payable: The amount your company owes to other companies or creditors
- Loans payable: Business loans and other types of loans your company owes
- Income taxes payable: How much your company must pay for in taxes
- Utilities: The amount your company must pay for resources like gas, electricity and water
- Long-term debt: Loans that must be paid after a one-year period
- Accrued wages: What your company must pay your employees
Your company can track your debts to other companies, what you owe your employees, taxes and other obligations in this section.
What is shareholder’s equity?
Shareholder’s equity is the ownership stake that investors have in the company. It’s the amount that would be paid to stockholders if a company was completely liquidated, meaning all assets were converted to cash and all debts and obligations were paid off.
This also includes retained earnings that can be injected back into the business to help it grow and produce even higher profits for its shareholders. Here are a few line-items you’d see on the equity section of a balance sheet.
- Retained earnings: The amount of income a company has made after paying any dividend to stockholders
- Common stock: Stocks that give voting power and the ability to share profits via dividends
- Preferred stock: Stocks that give even more power than common stocks and have priority when it comes to dividend payments
- Treasury stock: Stock that the company owns
Sole proprietorships and partnerships won’t need to worry about stock within the shareholder’s equity section. Corporations are the only types of companies that can offer stocks. If you don’t operate a corporation, then you should only worry about the retained earnings line item.
An ongoing balancing act
Now that you know exactly what goes into each section of your balance sheet, you can better organize your company’s financials. You should diligently track your income and expenses every month to stay on top of exactly what’s happening with your business.
By creating a balance sheet every month, you can compare your financials from month to month and know if your business is doing well or if you need to make some adjustments moving forward.
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