A balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities and shareholders' equity聽every time.

Understanding Balance Sheets

The assets on the balance sheet consist of what a company owns or will receive in the future and which are measurable. Liabilities are what a聽company owes, such as taxes, payables, salaries, and debt. The shareholders' equity section聽displays the company's retained earnings and the capital that has been contributed by shareholders. For the balance sheet to balance, total assets should equal the total of liabilities and shareholders' equity.聽

The balance between assets, liability,聽and equity makes sense when applied to a more straightforward聽example, such as buying a car for $10,000. In this case, you might use a $5,000 loan (debt), and $5,000 cash (equity) to purchase it. Your assets are worth $10,000 total, while your debt is $5,000 and equity is $5,000. In this example, assets equal debt plus equity.

Why a Balance Sheet Balances

The major reason that a balance sheet balances are the accounting principle of double entry. This accounting system records all transactions in at least two different accounts, and therefore also acts as a check to make sure the entries are consistent.

Building on the previous example, suppose you decided to sell your car for $10,000. In this case, your asset account will decrease by $10,000 while your cash account, or account receivable, will increase by $10,000 so that everything continues to balance.

Assets

Assets are the first of three major categories on the balance sheet. Current assetsrepresent聽the value of all assets that can reasonably expect to be converted into cash within one year and are used to fund ongoing operations and pay current expenses. Some examples of current assets include聽

Noncurrent assets聽are a company鈥檚聽long-term investments聽or any asset聽not classified as current. Both聽fixed assets, like plant and equipment, and聽intangible assets, like trademarks fall under noncurrent assets.聽Some examples of noncurrent assets are:

  • Land
  • Property, plant, and equipment
  • Trademarks
  • Long-term investments and even聽goodwill

Liabilities

Current liabilities are short-term liabilities that are due within one year and include:聽

  • Accounts payableare a short-term debt owed to聽suppliers.
  • Accrued expenses聽are expenses that have yet to be paid, but have a high probability of being paid.

Noncurrent liabilities聽are also listed on the balance sheet and are聽included in the calculation of a company's total liabilities. Noncurrent liabilities are long-term debts or obligations and unlike current liabilities, a company does not expect to repay its non-current liabilities within a year. Some examples of noncurrent liabilities include:

  • Long-term聽lease聽obligations
  • Long-term debt聽like bonds payable

For example, a company's long-term lease that lasts more than one fiscal year is listed on the balance sheet. The rental arrangement is listed as an asset on the balance sheet, and the lease obligation is listed as a liability. Since the lease lasts longer than one fiscal year, it is a noncurrent liability.

Shareholders' Equity

'Retained earnings'is money聽held聽by a company to either reinvest in the business聽or pay down debt. 'Retained earnings' are also earnings that have not been paid to shareholders via dividends.聽

Shareholders' equity聽is the net of a company's total assets and its total liabilities. Shareholders' equity represents the net worth聽of a company and helps to determine its financial health. Shareholders' equity is the amount of money that would be left over if the company paid off all liabilities such as debt in the event of聽a liquidation.聽

Balance Sheet Example聽

Below is Apple's聽balance sheet, as of the end of their聽fiscal year for 2017, from their聽annual聽聽We can see how the balance sheet balances by the following:

  • Total assets were $375 billion.
  • Total liabilities were $241 billion.
  • Shareholders' equity was $134 billion (highlighted in yellow).聽

At the bottom聽of the balance sheet, we can see that total聽liabilities and shareholders' equity are added together to come up with $375 billion聽which balances with Apple's total聽assets.

If the balance sheet you're working on does not balance, it's an indication that there's聽a problem with one or more of the accounting entries.聽