In plain English
A balance sheet has two columns that must add to the same total. On one side, everything the company owns: cash, stock on the shelves, money customers owe, buildings and machines. On the other, everyone with a claim on it: suppliers, the bank, and last of all the owners. Owners get the leftovers, which is why equity is the balancing figure.
The advanced view
Balance-sheet values are mostly historical cost less accumulated depreciation, not market value, and intangible value created internally is largely absent. So book equity is a residual accounting figure, not a valuation. Current versus non-current classification exists to expose liquidity: the split tells you what must be settled inside twelve months against what funds the business long term.
'Current' means within twelve months. Current assets — cash, receivables, inventory — are expected to turn into cash within a year. Current liabilities — payables, overdrafts, the next year of loan repayments — must be settled within a year. Everything else is non-current: factories, long-term loans, and so on.
The difference between current assets and current liabilities is working capital. It tells you whether the company can pay next year's bills out of next year's short-term assets. Negative working capital is not automatically bad — supermarkets run on it, because customers pay instantly and suppliers wait 60 days — but it is always worth explaining.
Balance-sheet arithmetic
Assets = Liabilities + Equity Equity = Assets − Liabilities Working capital = Current assets − Current liabilities
Essential vocabulary
- Receivables
- Money customers owe you for goods already delivered. An asset until they pay.
- Payables
- Money you owe suppliers for goods already received. A liability until you pay.
- Inventory
- Goods bought or made but not yet sold. Cash tied up on a shelf.
- Depreciation
- Spreading the cost of a long-lived asset over the years it is used, instead of expensing it all at once.
- Book value
- The value of something as recorded in the accounts — usually cost minus depreciation, not what it would fetch today.
Common pitfalls
- ×Reading book equity as what the company is worth. Market value and book value are different animals.
- ×Ignoring the maturity of debt — 100 of debt due next month is a different company from 100 due in ten years.
- ×Treating inventory as almost-cash. Unsold stock may never become cash at full value.
Why it works
Sorting claims by who gets paid first, and assets by how quickly they turn into cash, turns a list of numbers into a solvency test. That is why the ordering on a balance sheet is a convention worth respecting: it lines up the things that must be paid soon against the things that can pay them.
How it is used — walk through a tiny balance sheet
Step 1 of 6
- 1Cash 20, receivables 30, inventory 25 → current assets =
Deeper
Deeper: net debt, working capital and what the balance sheet hides
Analysts rarely use the balance sheet as printed. They regroup it: operating assets and liabilities on one side (invested capital), financing on the other (net debt plus equity). Net debt = interest-bearing debt − cash. Invested capital = equity + net debt = fixed assets + net working capital.
What the balance sheet hides matters as much as what it shows. Operating leases, pension deficits, contingent liabilities and off-balance-sheet vehicles are all real claims. Historic-cost accounting means a property bought in 1985 sits at a fraction of its value, while goodwill from a bad acquisition sits at full price until someone impairs it.
Must know cold
- ✓Net working capital = receivables + inventory − payables.
- ✓Net debt = interest-bearing debt − cash and equivalents.
- ✓Invested capital = equity + net debt.
- ✓Current ratio = current assets ÷ current liabilities; quick ratio strips inventory out.
More vocabulary
- Goodwill
- Excess paid over the fair value of net assets in an acquisition. Impaired when the deal underperforms.
- Deferred revenue
- Cash received before the service is delivered. A liability, and a good sign in SaaS.
- Intangibles
- Brands, software, licences. Amortised, and often the biggest asset in a modern company.
Exercises
Try each one on paper before revealing the worked solution.
Exercise 1
Assets 800 (of which cash 60, receivables 120, inventory 90), payables 70, other non-interest current liabilities 30, debt 250, equity 450. Compute net working capital, net debt and invested capital two ways.
Exercise 2
Why can a company with a current ratio of 2.0 still fail next month?