We are into our second part of the articles focusing on important components of a balance sheet.
A recap of a balance sheet.
It is a snap short of the company’s financial conditions on a particular date.
Conceptually, the balance sheet is based on the accounting equation, which states that the total amount of assets must balance the total amount of liabilities and owner’s equity.
Assets = Liabilities + Owner’s Equity.
Below is an image of a balance sheet
It is clear from the balance sheet below; it is broken into two areas.
- On top is the Asset
- Below the Assets contains the company’s liabilities and shareholders’ equity.
- The balance sheet is in balance where the value of the assets equals the combined value of the liabilities and shareholders’ equity.
Did you notice another interesting aspect of the balance Sheet?
Yes, how it is organized. The assets and liabilities sections of the balance sheet are organized by how current the account is. Meaning, the accounts are classified typically from most liquid to least liquid for example.
Today, we look in-depth into Asset section of the balance sheet.
Current assets (“Working Assets”)
- Cash and cash equivalents –
- Inventories – what the company needs to buy and what the company needs to sell
- Accounts receivables – money owned to the company
- Prepaid expenses- is expense paid in advance but which has not yet been incurred. If the Bakery pays advance rent to its landowner of $10,000 on 31st December 2010 in respect of rent of the premises for the following year. The bakery will recognize an asset of $10,000 in the financial statements of year 2010 in respect of the prepaid expense to recognize its right to use rented space in the following year.
They are called current because they are cash or they can be or will be converted into cash in a short period of time (usually within a year). They are also listed in the balance sheet in order of their liquidity, which means how quickly they can turned into cash.
What is important about them
- Should the business of the company start to stumble and other sources of day-to-day operating capital start to slowly dry up, it becomes important how fast the current assets can be converted to cash and be spent.
- It also shows how a company makes money
Let’s look at the example used in our previous article about a bakery. Cash is used to buy inventory such as supplies (flour, eggs, butter, sugar, paper cups, and equipment). The bakery sells cupcakes to the customer, if you invoice your customer $100, and if you have not collected the $100 yet, this $100 becomes accounts receivables. When you have collected $100 from the customers, the account receivables are converted into cash. If you collect cash directly, there are no account receivables.
This cycle repeats itself over and over again and that is how a company makes money!
Hope you learn some interesting facts about assets. Please look forward to our next article where we cover more about long term assets .
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