The Balance Sheet
A snapshot of financial position
Why This Matters
Imagine you're buying a company. The seller shows you last year's income statement: “$100,000 profit!”
You're excited. But then you realize: That profit could be sitting in cash, or it could be tied up in inventory, or they could owe $500,000 in debt.
Income Statement:
“How much did you earn this year?”
Balance Sheet:
“What are you worth right now?”
The balance sheet is the truth about what a company actually owns and owes at this moment.
What Is a Balance Sheet?
The balance sheet (also called the statement of financial position) is a financial report showing assets, liabilities, and equity at a specific point in time.
It's called a “balance sheet” because it must always balance:
ASSETS = LIABILITIES + EQUITY
The fundamental equation of accounting
This isn't a coincidence—it's the foundation of double-entry accounting.
The Three Sections
ASSETS
Resources the company owns that have economic value.
LIABILITIES
Obligations the company owes to others.
EQUITY
The owner's stake—what's left after liabilities are paid.
Current vs. Long-Term: The Key Classification
Current (Within 12 Months)
Current Assets
Convert to cash or use up within one year:
- Cash
- Accounts Receivable
- Inventory
- Prepaid Expenses
Current Liabilities
Must be paid within one year:
- Accounts Payable
- Salaries Payable
- Unearned Revenue
Why it matters: Shows short-term liquidity—can you pay your bills?
Long-Term (Over 12 Months)
Long-Term Assets
Provide value for more than one year:
- Property & Equipment
- Land (never depreciated)
- Long-Term Investments
- Intangible Assets
Long-Term Liabilities
Due after more than one year:
- Mortgages
- Corporate Bonds
- Multi-year Loans
Why it matters: Shows long-term financial structure and solvency.
Standard Balance Sheet Format
ACME CORPORATION
Balance Sheet
As of December 31, 2026
ASSETS
Current Assets
Long-Term Assets
LIABILITIES
Current Liabilities
Long-Term Liabilities
EQUITY
Notice how Assets ($335,000) = Liabilities ($155,000) + Equity ($180,000). This equation must always balance!
Real-World Example: ABC Coffee Shop
Let's build a complete balance sheet for ABC Coffee Shop as of December 31, 2026:
Gather the Data
Assets:
- Cash: $45,000
- Accounts Receivable: $8,000
- Inventory: $12,000
- Prepaid Insurance: $1,100
- Equipment: $50,000
- Accum. Depreciation: ($5,416.67)
Liabilities:
- Accounts Payable: $10,000
- Salaries Payable: $2,000
- Bank Loan: $6,000
Equity:
- Owner's Capital: $50,000
- Retained Earnings: $42,683.33
Build the Statement
ABC COFFEE SHOP
Balance Sheet
As of December 31, 2026
ASSETS
Current Assets
Long-Term Assets
LIABILITIES
Current Liabilities
Long-Term Liabilities
EQUITY
Assets ($110,683.33) = Liabilities ($18,000) + Equity ($92,683.33) ✓
Key Metrics from the Balance Sheet
Working Capital
Current Assets - Current Liabilities
Example: $66,100 - $12,000 = $54,100
Meaning: The company has $54,100 in short-term resources available to cover short-term obligations.
Healthy range: Positive working capital indicates healthy liquidity
Current Ratio
Current Assets ÷ Current Liabilities
Example: $66,100 ÷ $12,000 = 5.5
Meaning: For every $1 of short-term debt, the company has $5.50 in short-term assets.
Healthy range: Above 1.5 is strong; below 1.0 may signal trouble
Debt-to-Equity Ratio
Total Liabilities ÷ Total Equity
Example: $18,000 ÷ $92,683.33 = 0.19 (19%)
Meaning: The company has 19¢ of debt for every $1 of owner's equity.
Healthy range: < 1.0 = Strong, 1-2 = Reasonable, > 2 = High leverage
Reading a Balance Sheet Like an Investor
ABC Coffee Shop Analysis
ASSETS
$110,683
60% Current, 40% Long-Term
LIABILITIES
$18,000
16% of total
EQUITY
$92,683
84% of total
Strong equity position (84% equity-financed)
Low debt (16% debt-financed)
Good liquidity (60% current assets)
Working capital of $54,100 (very comfortable)
Conclusion: Safe, stable business. Low financial risk.
Common Balance Sheet Errors
Error #1: Not Balancing
Wrong
Assets: $100,000
Liabilities & Equity: $95,000
Doesn't balance!
Right
Assets: $100,000
Liabilities & Equity: $100,000
Balanced!
Error #2: Mixing Current & Long-Term
Wrong
Current Assets: $50,000
(includes a 5-year investment)
Right
Current Assets: $40,000
Long-Term Assets: $10,000
(5-year investment)
Error #3: Using Wrong Valuations
Wrong
Equipment: $50,000
(current market value)
Right
Equipment: $50,000 (cost)
Accum. Depr: ($10,000)
Net: $40,000
(historical cost basis)
Balance Sheet vs. Income Statement
| Aspect | Balance Sheet | Income Statement |
|---|---|---|
| Time | Point in time (snapshot) | Period of time (film) |
| Example Date | Dec 31, 2026 at 11:59 PM | Jan 1 - Dec 31, 2026 |
| Shows | Position / Worth | Performance / Profitability |
| Question | “What do we own/owe?” | “Did we make money?” |
| Equation | A = L + E | R - E = NI |
| Accounts | Permanent accounts | Temporary accounts |
Key Takeaway
The balance sheet is a snapshot of financial position at a specific moment. It shows what the company owns (assets), what it owes (liabilities), and what's left for the owner (equity). The fundamental equation—Assets = Liabilities + Equity—must always hold. By analyzing current vs. long-term items, and by calculating ratios like working capital and debt-to-equity, you can assess the company's financial health and ability to meet obligations.
Test Your Understanding
1. Which is NOT typically a current asset?
2. A company has Current Assets of $100,000 and Current Liabilities of $40,000. What is Working Capital?
3. If Assets = $500,000 and Equity = $300,000, what are Total Liabilities?
4. Accumulated Depreciation appears on the balance sheet as:
5. True or False: The balance sheet equation must ALWAYS balance if entries are recorded correctly.
Ready to Practice?
Build your own balance sheets
You now understand how to read and build a balance sheet. The Practice Lab is where you'll take trial balances, classify assets and liabilities, and build complete balance sheets that balance.
Try the Practice Lab