Balance sheets: a snapshot of your financial condition

Last time we discussed the Asset side of the balance sheet. Now on to the other side, that “balances” with the Asset side (i.e. equals the total assets), and is called “Liabilities and Equity.”

Equity can be considered a form of liability, in the economic sense, if not in the accounting sense. It’s a claim the owners of the company have, in that they expect to receive a “return” on their investment(s). Such returns can be dividends, profits, and/or gains.

So, to review our definitions of terms:

Assets are things of value that you own, or have a right to use

Liabilities are things you owe; you will be paying to someone at some time in the future

Equity is the amounts that the owners (i.e. shareholders, members, partners, etc.) have contributed to the company in return for an ownership interest; and the accumulated net income (or net loss) of the business, up to the point in time of the balance sheet, Part 1 of which appeared in this column, the last time.

What kinds of things are considered liabilities?

Accounts Payable: What the company owes to other companies or individuals for products or services purchased from them. The company will have received a “bill” that is entered into Accounts Payable. And will be paying the bill at some time in the future, at which time the amount of Accounts Payable will be “relieved” (i.e. wiped to zero).

Accrued Expenses: Expenses incurred by the company, but for which there is no bill. An example would be payroll costs. If payday for the last week of the month is in the next period, the company would need to “accrue” the amount of the payroll that will be paid next period.

Current portion of long-term debt: The amount that is due and payable within twelve months of the date of the balance sheet. Remember: only the principal component of debt is recorded on the balance sheet. The interest component is recorded as an expense in the profit & loss statement (“P&L”).

Deferred revenue: Monies or deposits received from customers in advance of the company providing the service. So the company has been paid but has not earned the ability to recognize the revenue (in the P&L) yet. This amount will be recorded in revenue in the future.

Long-term debt: The total principal portion of debt that is due and payable, more than twelve months into the future.

Preferred stock: A hybrid ownership instrument that has characteristics of both debt and equity. I will dedicate a future blog to this because it is the usual means that an early investor gets to invest in a start-up, where the preferred stock is “convertible” into equity shares. If that happens, life is good because the business is successful. (That’s what it’s all about!)

Equity: The amount of ownership interest in the company — the amount that was invested by the owners, shareholders, partners, members, etc.

Retained earnings: The accumulated amount of profit from prior years. If it says “Accumulated Deficit”, that means the company has lost money in prior years, and/or hasn’t earned profits enough to wipe out the deficit. Bad!