Reading a Balance Sheet

First, however, find a sample balance sheet, either your own company’s or one in an annual report (or just look at the sample below). Since the balance sheet shows the company’s financial situation at a given point in time, there should be a specific date at the top. It’s usually the end of a month, quarter, year, or fiscal year. When you’re looking at financial statements together, you typically want to see an income statement for a month, quarter, or year, along with the balance sheet for the end of the period reported. Unlike income statements, balance sheets are almost always for an entire organisation. Sometimes a large corporation creates subsidiary balance sheets for its operating divisions, but it rarely does so for a single facility. As we’ll see, accounting professionals have to do some estimating on the balance sheet, just the way they do with the income statement. Remember the delivery business? The way we depreciate the truck affects not only the income statement but also the value of assets shown on the balance sheet. It turns out that the assumptions and biases in the income statement flow into the balance sheet one way or another.

Balance sheets come in two typical formats. The traditional model shows assets on the left-hand side of the page and liabilities and owners’ equity on the right side, with liabilities at the top. The less traditional format puts assets on top, liabilities in the middle, and owners’ equity on the bottom. Whatever the format, the “balance” remains the same: assets must equal liabilities plus owners’ equity. (In the non-profit world, owners’ equity is sometimes called “net assets”). Often a balance sheet shows comparative figures for, say, 31 December of the most recent year and 31 December of the previous year. Check the column headings to see what points in time are being compared.

As with income statements, some organisations have unusual line items on their balance sheets that you may not find discussed in this course. Remember, many of these items may be clarified in the footnotes. In fact, balance sheets are notorious for their footnotes. Ford Motor Company’s 2004 annual report contained a whopping thirty pages of notes, many of them pertaining to the balance sheet. Indeed, companies often include a standard disclaimer in the notes making the very point about the art of finance that I am making in this course. Ford, for instance, says:

Use of Estimate

The financial statements are prepared in conformity with generally accepted accounting principles in the United States. Management is required to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those assumptions. Estimates and assumptions are periodically reviewed, and the effects of any material revisions are reflected in the financial statements in the period that they are determined to be necessary.