Chapter 4
The balance sheet

The balance sheet lists everything that your company owns, and balances it against who owns what. Part is owned by creditors (the debt or liabilities) and part by owners (the capital or equity). The balance sheet may have other names, including the statement of financial condition, statement of position, or statement of assets, liabilities and equity — income tax basis.
Regardless of the name, the basic formula for all balance sheets is:

Assets = Liabilities + Equity

The example everyone understands is that the total value of your home balances with the sum of the mortgage, plus your equity. A house valued at $100,000 and a mortgage of $80,000, has equity of $20,000. The balance sheet is the sum total of your company’s financial condition on a particular date, such as the end of a year, a quarter or a month.

The balance sheet uses book value — the value you carry on your books for the company’s assets and the debts you owe on those assets. It is one estimate — but only a very rough estimate — of what you would get if you closed shop, liquidated all assets and paid all debts. The net result in funds left over for the owners would be your equity. (As we’ll see in Chapter 19, “What Your Financial Statements Don’t Tell You,” the balance sheet portrayal of equity often doesn’t square with reality.)
A more detailed look at a balance sheet reveals the following format:

The balance sheet often will be more detailed than this. For example, although the balance sheet technically only shows the snapshot dates, often it will display multiple periods to give the most recent date some historical perspective. Some may even show columns for percentage of total assets.

In annual reports prepared by accounting firms, often only two columns are presented; this fiscal year-end and last. More-detailed reports may show a change between two periods or display up to three to five fiscal year- end columns.

Very detailed internal reports may show columns reflecting this fiscal month-end versus the same fiscal month one year ago, or against the previous fiscal year-end date, with changes. But all balance sheets are built the same way. And each category contains generally the same types of assets:

SCU TRUCKING CO.
BALANCE SHEETS

		December 31	1997	1998	1999
		ASSETS
		Current Assets
		Cash and cash equivalents	$245,000	$210,000	$263,500
		Trade accounts receivables, net of allowance for doubtful accounts of $-0-	925,000	885,300	967,000
		Receivables from related parties	25,000	22,000	65,000
		Inventories	6,000	18,000	25,000
		Prepaid expenses and other	25,000	27,000	35,000
		Total Current Assets	1,226,000	1,162,300	1,355,500
		Property and Equipment (Fixed Assets)
		Transportation vehicles	1,145,000	1,367,000	1,475,000
		Transportation vehicles - capital leases	275,000	275,000	475,000
		Other vehicles and equipment	235,000	235,000	235,000
		Leasehold improvements	215,000	215,000	215,000
			1,870,000	275,000	475,000
		Less: Accumulated depreciation and amortization	(675,000)	(875,000)	(1,025,000)
		Total Property and Equipment	1,195,000	1,217,000	1,375,000
		Other Assets
		Cash value of life insurance	25,000	38,000	47,000
		Deposits	12,000	12,000	45,000
		Other	7,500	7,500	7,500
		Total Other Assets	44,500	57,500	99,500
		TOTAL ASSETS	2,465,500	2,436,800	2,830,000
		LIABILITIES
		Current Liabilities
		Trade accounts payable	189,5000	227,000	245,000
		Accrued expenses and other liabilities	95,000	86,000	103,000
		Current portion of long-term debt	125,000	132,000	175,000
		Total Current Liabilities	409,500	445,000	523,000
		Long-Term Debt, Net of Current Portion	625,000	617,000	725,000
		Total Liabilities	1,034,500	1,062,000	1,248,000
		Commitments
		STOCKHOLDERS' EQUITY
		Common Stock	125,000	125,000	200,000
		Retained Earnings	1,306,000	1,249,800	1,382,000
		Total Stockholders' Equity	1,431,000	1,374,800	1,582,000
		TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	2,465,500	2,436,800	2,830,000

Current assets are those that are within one year, generally, of being turned into cash. Common current assets include cash, short-term investments, accounts receivable, advances to drivers, inventory of supplies, prepaid expenses (such as insurance or tax deposits) and any other asset that is expected to be liquidated within a year.

Fixed assets are generally those that you will carry on the books for more than one year, and from which you will benefit in future years. The best example of fixed assets is your fleet of trucks and trailers, which (you hope) will last several years. Other fixed assets might be office equipment, shop equipment, buildings and land, or, if you lease your shop but must improve it to your specifications, leasehold improvements.

Fixed assets are recorded at their original purchase price, NOT their market value. Over the time you use the asset, you try to allocate a portion of this cost and deduct it against the P&L each reporting period. An attempt is then made to allocate this original cost and “write it off” or deduct it against the P&L over the time that the asset is used. This deduction is called depreciation, and it’s an expense on the P&L. Suppose a $100,000 truck lasts four years. Under one method of depreciation, $25,000 would depreciate each year.

The next part is intuitive ONLY to accountants. Continuing our example, the original cost of $100,000 is carried on the balance sheet every year. An unusual fixed asset component called accumulated depreciation is deducted after the cost is listed, reducing the original cost to net book value. In this example, at the end of year one, $25,000 was deducted, so accumulated depreciation is shown at $25,000 and the subtotal results in the net book value of $75,000. At the end of year two, the accumulated depreciation is $50,000, so the net book value is reduced to $50,000, and so forth.

To make matters more confusing, accountants’ presentations of fixed assets vary. Some balance sheets show all the details on the face of the statement, and some show only fixed assets net of accumulated depreciation. In the latter case, you must seek out the supplementary information or footnote disclosures to find the details.

Other assets are neither current nor fixed. They either have a carrying period (i.e., time until liquidation) of more than one year, or are intangible in nature. Intangible assets might be a contract right, such as a franchise, or some cost that tax or accounting rules say should be allocated over several years.

Other assets also include notes receivable for sale of old equipment where the maturity of the note stretches out over several years, officer loans that have no stated maturity date, investments or advances to subsidiary companies.

Other assets may also include costs that must be amortized over several years, such as non-compete agreements with former owners; the cost of franchises; and the legal, accounting and other costs needed to start a business or acquire a major bank loan.

Total assets are nothing more than the total of the three subcategories. As we’ll see later, growing total assets doesn’t necessarily mean the company is growing. It’s important that as assets grow, debt and equity grow in the same proportions.

Current liabilities are those that you will pay in the next 12 months. All business owners instantly object: “If it’s not due by the 10th of the month, how can it be called current?” That’s a fair question, and the answer is: just because. It’s simply a bean counter’s rule — generally accepted accounting principles, or GAAP.

The goal is to determine whether there are enough current assets to liquidate all current liabilities at any given point in time. In any ongoing business, you will always have current assets, because you never fully collect all receivables or have zero advances to drivers. You “finance” many of your current assets with ongoing current liabilities so you always owe someone at the end of any given month.

Current liabilities include:

• Short-term bank notes and lines of credit;
• Accounts payable to trade vendors for fuel and shop supplies;
• Taxes due for payroll and excise taxes collected in the previous month but not paid until the next;
• Income taxes; and
• Payroll and driver settlements for periods ending during the month but not paid until the next.

One difficult-to-understand component of current assets is current maturities of long-term debt. It’s a concept of GAAP that current liabilities include all payments expected to be due within the next 12 months. Thus, on a $1 million loan financing a number of trucks for five years, about $200,000 in principal will be due in the next 12 months. Current liabilities should show this amount by removing it from long-term liabilities, leaving only $800,000 in that category.

Long-term liabilities are debts you expect to pay after 12 months from the report’s date. This would include bank or equipment financing debt maturities scheduled beyond 12 months’ time, bonds, debentures and any obligation of the company that is not current.

One liability that may have both a current and non-current component is deferred taxes. As we’ll explain in a later chapter, the way you report income on financial statements, called “book basis,” may be different from the way you report income for income tax purposes. A deferred tax liability is an obligation for the amount of tax that would be due today if the two separate bases of accounting were instantly reported on the company’s tax returns.

Other liabilities may include loans and special debts not classified elsewhere. One difficult to understand accounting concept is the shareholder loan. When owners invest funds in their company, it is usually called equity capital. But sometimes owners’ funds are treated as a company debt for tax reasons and are listed among the liabilities.

Equity represents the amount owed to the owners that is not classified as shareholder debt. This section of the balance sheet may have various names, depending on the type of legal entity. For corporations, this section is called stockholder’s equity, partnerships call it partner’s capital, limited liability companies (LLCs) call it member’s capital and sole proprietorships call it proprietor’s capital.

As mentioned in Chapter Two, equity has several components, including the amount invested by the owners, plus or minus the retained earnings.

The amount invested by owners is called capital stock or additional paid-in capital for corporations and capital invested for the other types of legal entities.

Accountants’ presentation of the equity varies widely. Some may show only a single line on the face of the balance sheet, with details spelled out somewhere else in the report. Others show the breakdown on the face of the statement, listing the components of capital, retained earnings at the beginning of the year, plus current profits, minus distributions, to arrive at retained earnings at the end of the year.

In Summary
The balance sheet measures the company’s financial position for an instant in time, usually the end of the fiscal year. It reflects the total assets of the company at book values, not current market values. Formats may vary, but the basic formula of presentation remains the same for all balance sheets:

assets = liabilities + equity.