Join Jim Stice for an in-depth discussion in this video The balance sheet, part of Accounting Foundations: Bookkeeping.
- Before we get into the complexities of analyzing transactions and such. Let's step back and look at what this analyzing of transactions eventually results in, Financial Statements. One of the major results of bookkeeping is to provide information with which individuals can make decisions. Financial statements are a means whereby the effects of lots of transactions are summarized and reported in a manner that is useful to users of financial statements. The three most common Financial Statements are: the Balance sheet, the Income statement, and the Statement of cash flows.
Let's take a look at each of these in turn. Now, we'll start with the mother of all financial statements, the Balance sheet. The Balance sheet is called the fundamental financial statement. It contains a listing of a company's assets. Its resources, its valuable things, its cash, its land, its inventory, those things that it holds to sell. Those are its assets. The other part of the Balance sheet is a listing of where the company got the money to buy those assets, the liabilities and the equities. The Balance sheet embodies the accounting equation.
One of the greatest inventions of the human mind, invented in Italy over 500 years ago. A list 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 our valuable resources. They are items that will provide us benefit in the future. Cash, for example, is the asset that we can all quickly identify.
If you look at the balance sheet of Apple, for example. You see that Apple had on September 27th, 2014 $13.8 billion in cash. Now, that's a lot of money. But it's not even close to being Apple's biggest asset. Another asset, Accounts receivable. Money that is owed by other people to a company. That's another common asset. Continuing the Apple example, at the end of December 2014, customers owed Apple almost $17.5 billion.
Apple also had inventory. All those iPads, iPods, iMacs, and iPhones. At the end of December 2014, they totaled over $2 billion. Property, plant and equipment, or PP & E. All of those are resources that a company uses in accomplishing its objectives. Apple had over $20 billion in Property, plant and equipment. But Apple's biggest asset was its Long-term marketable securities. The stocks and bonds of other companies that they have 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 those $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 those sources? Well, one possible source is liabilities. Liabilities are obligations to repay money or to provide a service in the future. Consider Walmart for example. Where does Walmart get most of its inventory? That is 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. Well, Disney's borrowed money on a long-term basis. Sometimes a very long-term basis, over a hundred years.
Would you loan money to somebody for a hundred years? Well, maybe not to everybody. But you'd loan the money to Disney because they're good for it in a hundred years. United Airlines has a very interesting liability. When you and I fly on United, we pay first and fly later. In the interim, United Airlines owes us a ride on an airplane. That's an obligation. That's a liability that's listed on United Airlines' balance sheet. At the end of 2014, the obligation to provide airplane rides to people who had already paid, totaled over $3.7 billion for United.
Okay, let's go back to Apple. Their biggest liability was Accounts payable. Companies they'd purchased assets from and had yet to pay for. The amount of the 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 the 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 that Paid-in capital. That's one way that owners invest in their company. A second way, that owners invest in a company is by leaving profits in the company. We call this Retained Earnings. The profits of a business belong to the owner. The owners can take those profits out and use them to buy groceries, or to buy a boat, or whatever else they want.
Or the owners can say let's put those profits back in the business. Again, we call that 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 of earnings that have been retained.
To review, remember that Apple had assets of $232 billion? How did they finance those assets? Well, $120 billion worth were funded through liabilities. And the remainder were financed by owners to the tune of about $112 billion. 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 owner's equitiy. It has to balance by definition.
This is important so let me say it one more time. The accounting equation always balances. Always. Now, we can look at a couple of other companies to show how their balance sheets balance. 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 assets with liabilities. But they all have one thing in common, their assets exactly equal their liabilities plus their owner's equity.
Even those 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 equal Liabilities plus Equity. Check it for each one and you'll see that they add up.
- Reviewing financial statements
- Analyzing transactions
- Categorizing transactions
- Recording a cash acquisition
- Recording the sale of goods or services
- Posting journal entries to accounts