discuss each of these assets in other chapters in this book (starting with Chapter 7), but here’s a brief description of each to get you started:
Cash: Cash includes accounts such as the company’s operating checking account, which the business uses to receive customer payments and pay business expenses, and imprest accounts, in which the company maintains a fixed amount of cash, such as petty cash. Petty cash refers to any bills and coins the company keeps handy for insignificant daily expenses. For example, the business runs out of toilet paper in the staff bathroom and sends an employee to the grocery store down the block to buy enough to last until the regular shipment arrives.
Accounts receivable: This account shows all money customers owe to a business for completed sales transactions. For example, Business A sells merchandise to Business B with the agreement that B pays for the merchandise within 30 business days. Business A includes the amount of the transaction in its accounts receivable.
Inventory: For a merchandiser — a retail business that sells to the general public, like your neighborhood grocery store — any goods available for sale are included in its inventory. For a manufacturing company — a business that makes the items merchandisers sell — inventory also includes the raw materials used to make those items. See both Chapters 7 and 13 for more information about inventory.
Fixed assets: The company’s property, plant, and equipment are all fixed assets. This category includes long-lived tangible assets, such as the company-owned car, land, buildings, office equipment, and computers. See Chapters 7 and 12 for more information about fixed assets.
Prepaid expenses: Prepaids are expenses that the business pays for in advance, such as rent, insurance, office supplies, postage, travel expense, or advances to employees.
Other assets: Any other resources owned by the company go into this catch-all category. Security deposits are a good example of other assets. Say the company rents an office building, and as part of the lease it pays a $1,000 security deposit. That $1,000 deposit appears in the “other assets” section of the balance sheet until the property owner reimburses the business at the end of the lease.
Liabilities
Liabilities are claims against the company’s assets. Usually, they consist of money the company owes to others. For example, the debt can be owed to an unrelated third party, such as a bank, or to employees for wages earned but not yet paid. Some examples of liabilities are accounts payable, payroll liabilities payable, and notes payable. I fully discuss each of these liabilities in Chapter 8. For now, here’s a brief description of each:
Accounts payable: This is a current liability reflecting the amount of money the company owes to its vendors. This category is the flip side of accounts receivable because an account receivable on one company’s balance sheet appears as an account payable on the other company’s balance sheet.
Payroll liabilities: Most companies accrue payroll and related payroll taxes, which means a company owes its employees money but has not yet paid them. This process is easy to understand if you think about the way you’ve been paid by an employer in the past. Most companies have a built-in lag time between when employees earn their wages and when the paychecks are cut.In addition to recording unpaid wages in this account, the company also has to add in any payroll taxes or benefits that will be deducted from the employee’s paycheck when the check is finally cut.
Short-term notes payable: Notes payable that are due in full less than 12 months after the balance sheet date are short-term — or could be the short-term portion of a long-term note. For example, a business may need a brief influx of cash to pay mandatory expenses such as payroll. A good example of this situation is a working capital loan, which a bank makes with the expectation that the loan will be paid back from the collection of the borrower’s accounts receivable.
Long-term notes payable: If a short-term note has to be paid back within 12 months after the balance sheet date, you’ve probably guessed that a long-term note is paid back after that 12-month period! A good example of a long-term note is a mortgage. Mortgages are used to finance the purchase of real property assets (see Chapters 7 and 12).
Equity
Equity shows the owners’ total investment in the business, which is their claim to the corporate assets. As such, it shows the difference between assets and liabilities. It’s also known as net assets or net worth. Examples of equity are retained earnings and paid-in capital. I fully discuss both equity accounts in Chapter 9. For now, here’s a brief description of each:
Retained earnings: This account shows the result of income and dividend transactions. For example, the business opens on March 1, 2021. As of December 31, 2021, it has cleared $50,000 (woohoo!) but has also paid $10,000 in dividends to shareholders. The retained earnings number is $40,000 ($50,000 – $10,000).Retained earnings accumulate year after year — therefore the “retained” in the account name. So, if in 2022 the same business makes $20,000 and pays no dividends, the retained earnings as of December 31, 2022, are $60,000 ($40,000 + $20,000).
Paid-in capital: This element of equity reflects stock and additional paid-in capital. Nope, you’re not seeing a typo! There is a paid-in capital account called “additional paid-in capital.” In brief, here’s what the two types of equity are:Stock: Corporations raise money by selling stock — pieces of the corporation — to interested investors. Stock sold to investors usually comes in two different types: common and preferred. Each type of stock has its own characteristics and advantages, which I discuss fully in Chapter 9.Additional paid-in capital: This equity account reflects the amount of money the investors pay over the stock’s par value. Par value is the price printed on the face of the stock certificate and quite often is set at a random dollar amount. For example, if the par value of JMS, Inc. stock is $10 per share and you buy 100 shares at $15 per share, additional paid-in capital is $500 ($5 times 100 shares).
Seeing an example of a classified balance sheet
A classified balance sheet groups together similar accounts so the financial statement user has an easier time reading it. In Chapter 7, I show you a blown-out balance sheet that is structured in accordance with generally accepted accounting principles (GAAP; see Chapter 4). In Figure 2-1, I give you a very abbreviated version of what a classified balance sheet looks like.
