The balance sheet is a snapshot at a single moment — the last day of the quarter or year. It tells you what the business owns, what it owes, and what's left for shareholders. The whole thing is held together by one identity:
The accounting identity
Assets = Liabilities + Shareholders' Equity. Always. If it doesn't balance, someone made an error or someone is hiding something.
Assets — what the company owns
Listed in order of liquidity (how quickly they convert to cash):
- Current assets: cash, marketable securities, accounts receivable, inventory, prepaid expenses — convertible to cash within 12 months
- Long-term assets: property/plant/equipment (PP&E), intangibles (patents, trademarks), goodwill, long-term investments
Liabilities — what the company owes
- Current liabilities: accounts payable, accrued expenses, short-term debt, deferred revenue (cash received but not yet earned)
- Long-term liabilities: long-term debt, deferred tax liabilities, lease obligations, pension liabilities
Equity — what's left over
After liabilities are subtracted from assets, equity is the residual claim of the owners. It's made up of:
- Common stock + APIC (additional paid-in capital) — what investors paid for shares
- Retained earnings — cumulative net income minus cumulative dividends
- Treasury stock — shares the company bought back (a contra-equity, subtracted from equity)
- Accumulated other comprehensive income (AOCI) — unrealized gains/losses on certain items
What the balance sheet actually tells you
Three questions you can answer just by reading it carefully:
- Is the business solvent? (Are total assets bigger than total liabilities? By how much?)
- Is it liquid? (Can current assets cover current liabilities?)
- Is it leveraged? (How much of the asset base is funded by debt vs equity?)
Goodwill is not gold
Goodwill is the premium paid in acquisitions over the fair value of net assets. It sits on the balance sheet and stays there until it's impaired. A company with $50B of goodwill out of $80B in assets has not really 'built' those assets — it bought them. That tells you something about the strategy and the risk.
Book value and what it doesn't tell you
Equity divided by shares outstanding gives book value per share. Comparing it to the market price gives you the price-to-book ratio. But book value reflects historical cost, not current value. A 50-year-old factory may be on the books at $0 and still worth $100M; a software company's most valuable asset (its team) doesn't appear at all. Book value works best for banks and insurers, where assets are mostly financial and marked to market.
Exercise
A company has total assets of $5B, total liabilities of $3B, and 200M shares outstanding. What is total equity, and what is book value per share?