Join Jim Stice for an in-depth discussion in this video Balance sheets, part of Finance for Non-Financial Managers.
- We will start with the mother of all financial statements, the balance sheet. The balance sheet embodies the accounting equation, one of the greatest inventions of the human mind, invented in Italy over 500 years ago. A listing of things we own, assets, is easy. Anybody can list assets. But the insight from the accounting equation is to then also list where did we get the money to buy those assets, the liabilities and the equities. Now assets, they're valuable resources. They are the items that will provide us benefit in the future.
Cash, for example, is the asset that we can all quickly identify. If you look, for example, at the balance sheet of Apple you'll see that Apple had on September 27, 2014 $13.8 billion in cash. Now that's a lot of money but that's not even close to being Apple's biggest asset. Accounts receivable, that's money that's owed by other people to a company. That's another common asset. Continuing the Apple example, at the end of September 2014, customers owed Apple almost $17.5 billion.
Apple also had inventory, all those iPods, iPads, iMax and iPhones at the end of September 2014. Apple had inventory of totaling over $2 billion. Another asset, land, buildings, equipment, all of these are resources that a company uses in accomplishing its objectives. Apple had $20.6 billion in property, plant and equipment. But Apple's biggest asset as of September 27, 2014 was long-term marketable securities.
These are the stocks and bonds of other companies that Apple has purchased. That amount totaled over $130 billion. Apple's total assets at the end of September 2014 totaled almost $232 billion, wow. Again assets are resources available to a company that will benefit that company in the future. Now how does a company finance its assets? How did Apple finance that $232 billion in assets? If a company has assets, then that same company also has to have sources of financing to buy those assets What are these sources? Well one possible source are liabilities.
Liabilities are obligations to repay money or to provide a service in the future. Consider, for example, Walmart. Where does Walmart get most of its inventory? That's the things that Walmart has on its shelf to sell to you and me. Well suppliers finance it. Suppliers say you can pay us later. We call those accounts payable. Other liabilities, Disney has borrowed money on a long-term basis, sometimes very long-term, a hundred years. Would you loan money to somebody for a hundred years? Well maybe not everybody, but you'd loan money to Disney to pay you back in a hundred years.
United Airlines has a very interesting liability. When you and I fly on United Airlines we pay first and fly later. In the interim, United Airlines owes us a ride on a plane. That's an obligation. It turns out that's a liability that's listed on United Airlines's balance sheet. At the end of 2014 that obligation to provide airplane rides to people who had already paid totaled over $3.7 billion. So let's go back to Apple. Their biggest liability was accounts payable, companies that they'd purchased assets from but hadn't yet paid for.
The amount of their accounts payable was $30.2 billion. Their second largest liability was long-term debt, totaling about $30 billion. Now you might ask why would a company with almost $14 billion in cash and $130 billion in marketable securities be borrowing money, but that's a discussion for another day. Suffice it to say that Apple's liabilities as of the end of September 2014 totaled $120 billion. Now the second source of financing to buy assets is owners' equity, money provided to the company by owners.
Owners can do this in two general ways. They can take money out of their pocket and invest it in the business. We call this Paid-in Capital. That's the first way that owners invest in their company. A second way that owners invest in a company is by leaving profits of the company in the business. We call these Retained Earnings. The profits of a business belong to the owners. The owners can take those profits out and use them to buy groceries or to buy a boat or whatever else they want to do. Or the owners can say let's put those profits back into the business.
We call those retained earnings. Paid-in capital and retained earnings are the amount of money that are provided to the company by the owners to then buy assets. In the case of Apple, owners have invested about $23.3 billion into the business. That's paid-in capital. And they have elected to leave in the business, since the business was started, about $89 billion. To review, remember that Apple had assets of $232B. Well how did they finance those assets? $120B worth were funded through liabilities and the remainder were financed by owners to the tune of about $112B.
Now the first thing to note is that they call this financial statement a balance sheet for a reason. It balances. The accounting equation requires Assets to equal Liabilities plus Owners' Equity. It has to balance by definition. The accounting equation always holds, always. We can look at a couple of other companies to show how their balance sheet balances. Consider the following, these three companies, United Airlines, General Motors, and Google vary in size and they vary in the degree to which they finance their assets with liabilities, but they all have one thing in common.
Their assets exactly equal their liabilities plus their owner's equity. Even though these are sophisticated companies, selling products that are quite innovative and technologically advanced, they still follow that same accounting equation that was invented by the Italians over 500 years ago, Assets = Liabilities + Equity. Check it for each one and you'll see that they add up. They always add up.
- Interpret financial reports and make decisions based on available data
- Manage inventory and receivables
- Create an accurate budget
- Cost a product or service
- Analyze customers
- Understand your income taxes
- Communicate your contribution to the bottom line