Balance Sheets Explained: 3 Components of a Balance Sheet

A balance sheet is a financial document that shows a company's current assets, liabilities, and stockholders' equity. A quick glance at the balance sheet of a small business or large corporation can give investors clues about the company's financial health and net worth at a specific point in time.

The term “balance sheet” originates from the idea that a healthy company’s assets should be equal to its liabilities and shareholders’ equity at any given time. Also known as a statement of financial position or statement of financial condition, a company's balance sheet can reveal the health of a business by contrasting its total assets with its total liabilities.

A typical balance sheet contains three core components: assets, liabilities, and shareholder equity.

1. 1. Assets: Assets represent all things of value that belong to the company. This includes liquid assets such as cash or cash equivalents, as well as incoming payments via accounts receivable or prepaid expenses that will produce more company value. Assets also include illiquid, long-term assets such as real estate and factory machinery. Despite the fact that they provide value to a company, immaterial assets such as intellectual property and intangible assets such as a healthy work environment or a strong leadership team typically don’t show up on balance sheets.
2. 2. Liabilities: Nearly all business owners have liabilities, or expenses necessary to keep the business going. Long-term liabilities and long-term debt include mortgage payments, interest payments, and installment plans on machinery. Short-term liabilities include employees’ salaries and monies owed to vendors for services or raw materials.
3. 3. Shareholder equity: Publicly traded companies raise money for working capital (or readily available capital) by selling shares in the company (typically common stock). Shareholders’ equity—also known as stockholders’ equity or owner’s equity—is the amount of money available after all liabilities have been paid.

A properly managed balance sheet should follow a simple accounting equation: total liabilities + total shareholder equity = total assets. This means that a company's assets and its financial obligations should balance at a one-to-one financial ratio. If a company's liabilities greatly exceed its net assets, it may run the risk of defaulting. Conversely, if a company's balance sheet shows an equity ratio that is skewed toward assets, the company might be in a place to take on more debt to grow.

In many real-world scenarios, a company's liabilities to creditors, shareholders, and employees may exceed its market value. In the case of such a company, the balance sheet will be skewed in the direction of liabilities and away from assets. Growing companies can survive such asset-to-liability unbalance provided that their shareholders remain confident in their long-term future.

Balance sheets and income statements are both important financial statements in the world of bookkeeping. The difference between them is subtle but important.

• Income statements: An income statement, which is better known to some as a profit and loss statement or cash flow statement, shows money flowing into the company via sales and investment returns as well as money exiting the company via accounts payable, salaries, income tax, and other financial liabilities. It offers a useful snapshot of the company's cash flow over a given period of time.
• Balance sheet: A balance sheet offers a more holistic topline snapshot of a company's financial health. It considers all forms of assets, all forms of liability, and all types of stockholder equity. In doing so, it can provide a broader financial image of the company than an income statement can. However, it lacks the quotidian detail of cash flow that a proper income statement can offer.

A well-run company’s accounting system will make both income statements and balance sheets available to shareholders and managers. Potential investors will expect access to balance sheets, but not all will expect to see income statements. The level of detail depends upon the specific relationship between the company and the investor.

Get the MasterClass Annual Membership for exclusive access to video lessons taught by business luminaries, including Sara Blakely, Chris Voss, Robin Roberts, Bob Iger, Howard Schultz, Anna Wintour, and more.