Companies create balance sheets to communicate their financial position to owners, managers and lenders. The balance sheet lists the company’s assets, liabilities and equity accounts. The basic format of the balance sheet is that assets equal liabilities plus equity. This format must always balance.
Assets represent anything the company owns. These include physical assets, intangible assets and financial assets. Physical assets include anything that takes up space, such as inventory or equipment. Intangible assets include items that do not take up physical space but represent a right the company has. These include patents, which give the company the exclusive right to an invention or process, or trademarks, which give the company the right to use a particular design or log on its products and marketing materials. Financial assets include anything that provides the company with financial resources, such as the company’s bank account or marketable securities.
Liabilities represent any claims against the company by others. These include money owed on current bills, money owed for long-term loans or services or products promised to customers. Money owed on current bills includes utility bills waiting to be paid or wages owed to employees for work already completed. Long-term loans include bonds the company issued to acquire financing for large projects. Services or products promised to customers include items that customers prepay for, such as magazine subscriptions or insurance coverage.
Owner’s equity represents the owner’s claim to the net worth of the business and exists only in sole proprietorships or partnerships. Owner’s equity consists of two primary accounts. Owner’s drawing refers to money the owner withdraws from the business for personal reasons. Owner’s drawing increases whenever the owner withdraws money. Owner’s capital represents the accumulated balance of the owner’s claim to the business. Owner’s capital increases when the owner invests money into the business and when the company earns a profit. Owner’s capital decreases when the company loses money or when the owner withdraws money from the company.
Stockholder’s equity represents the stockholder’s claim to the net worth of the business and exists only in corporations. Stockholder’s equity consists of several types of accounts. Capital stock represents the shares of stock sold to investors. Retained earnings represents money earned by the company and held for future activities. Dividends represent money paid out to investors.