Dissecting a Balance Sheet

On a balance sheet, the total amount of assets must always equal the total amount of liabilities and owner ‚ s equity. The balance sheet changes constantly. Money flows in and out of an organization as it receives payments, purchases goods, and makes other daily transactions. For this reason, the balance sheet is considered a snapshot of the mix of assets, liabilities, and owner ‚ s equity on a single specified date.

The balance sheet shown in figure 5-1 is an extremely simplified one, used to describe the concepts involved in managing financial position. In reality, there can be many unique types of assets and liabilities that an organization can use to produce income. Senior managers must manage the relative proportion of each type of asset, liability, and owner ‚ s equity within the balance sheet and between the balance sheet and the income statement. Whether the organization is maintaining the appropriate proportions , or balance, is tracked by calculating ratios of how big one item is relative to another.

To make the concept of proportions easier within the balance sheet, let ‚ s redraw a portion of the balance sheet as a graph, as shown in figure 5-2. This way, you can visualize the balance sheet as a yardstick.

Figure 5-2: Sample balance sheet chart.

The amount of assets must always equal the amount of liabilities and owner ‚ s equity. Figure 5-2 takes the amounts shown in ‚“This Year ‚ s ‚½ column in Figure 5-1 and lays them out side-by-side for assets and side-by-side for liabilities and owner ‚ s equity. This arrangement allows you to more easily see the relative size of each item on the balance sheet in proportion to the others.

Important ‚  

When communicating value, it is important to know that every item on a balance sheet has an optimal range for its size. What that optimum is varies depending on the organization and its industry norms. It will be important for you to discover the appropriate proportions for your target organization because anything that is out of proportion may signal a financial problem. If you can offer interventions that create better proportions, you will get the attention of your audience.

On a balance sheet, assets that will be converted into cash within a year are known as current assets. Other assets that will not be converted into cash within a year are known as long- term assets. One special case for cash in assets is accumulated depreciation, which will be covered in more detail later in this chapter.

A common example of a long-term asset is a manufacturing plant. ABC MediCompany ‚ s manufacturing plants are included under the item known as ‚“property, plant, and equipment. ‚½ Liabilities that will be paid within a year are known as current liabilities. Liabilities that will not be paid within a year are known as long-term liabilities.

 

The items on a balance sheet can be listed in any order. For assets, cash is often at the top of the list. Some accountants list items in order of their size. Others list assets in the order in which they can be most easily converted to cash, with cash being at the top of the list. Converting an asset into cash is called making the asset liquid. The easier it is to turn something into cash, the more liquidity the item has. Liabilities can be listed in the same way, with the items needing the most immediate use of cash listed first. Other liabilities and then the owner ‚ s equity may follow in descending order of their need for cash.