001: A Balance Sheet Example: How To Read A Balance Sheet

[leadplayer_vid id=”53AF92DB49C7A”]

The balance sheet is easy to understand… once you understand why what goes where. The balance sheet example on this page will help explain what the balance sheet is, how it’s organized, and how to interpret the information on it. The balance sheet is an extremely useful tool for all users to quickly get an idea of how a company is doing, and helps them make decisions with respect to the business.

A Balance Sheet Example: LawnMaster LLC

To make understanding this whole thing easier, we’re going to use an example. The lesson we’re going to use is you starting a lawn care business. Whether you love mowing the lawn or hate mowing the lawn, that’s the business you’re going into for our purposes here. And guess what your business’s name is?

LawnMaster. Decent name- especially since you thought of it yourself.

We’re also going to pretend that you’re 12 years old and that you’re starting as a pretty basic operation. Your seed funding came from your parents in the form of $300 for your birthday. So again, you’re 12 years old so you don’t have your Masters in Accounting yet, but you do know that you should do some sort of record-keeping for your business. So, you pull out a sheet of paper and you write down something that looks like this:

balance sheet example

The left side shows you what you have, and the right side will show you who owns it. You might be thinking, “well this is my business, so I own everything!” Well, not in accounting terms you won’t. It’s possible, but we’ll get into all that in a later lesson.

For right now, let’s think back to your seed money… the $300 your parents gave you for your birthday. It’s $300 in cash, and you own it. So, it will go on the left side, like this:

balance sheet example

So right now the only thing in your business is this $300. You need to list who owns it on the right side of the sheet… you happen to own this $300, but it could have been a loan that your parents gave you that you have to repay, so in that case it would have been someone besides yourself that owned the $300. But in our example, this is your own $300 that you’re starting your business with, so you’ll label it “original investment” on the right side of the sheet like this:

balance sheet example

There’s one important thing to notice at this point… the two sides balance. This will always be the case as long as you’ve entered the numbers correctly. Remember this:

The Left Side Will Always Equal the Right Side

Awesome. So you’ve got $300 of cash money to start your business with. You get your dad to take you to the hardware store, and you’re planning on buying a new lawnmower. You’re smart enough to know that you shouldn’t buy the cheapest one there is, but you also understand that you don’t need a $4,000 lawnmower at this point. As the salesperson shows you the different mowers, you start to realize that this is going to be more expensive than you thought…

The one you really want is $400… but you only have $300! Suddenly, you get an idea. “Dad, how would you like to invest in LawnMaster?”

After a big sales pitch and some sweet-talking on your part, your dad agrees to loan you the extra $100. Luckily, the terms are pretty loose: you can pay him back when you can. Sweet… so now you have $400, but two different people own parts of it. When you have a loan that you have to pay back to someone, it’s usually called a “note payable”. So, our sheet will now look like this:

balance sheet example

The two sides still balance, but now we have the $400 split up between two parties who own the $400 on the right side. We need to point out that your dad in this case is not an owner in your business. Since he gave you a loan that you have to pay back, he is a creditor… the same way the bank is the creditor when you get a car loan.

Let’s get a little bit more technical… When businesses fill out these sheets, they don’t write “what I have” and “who owns it” at the top… they have names for these things. The “what I have” part is called “assets” on the left side. On the right side, the “who owns it” part is divided into two parts as well: the part that the business owes money to, called “liabilities”, and the part that the business owns, or “owners’ equity”. It looks like this:

balance sheet example

Thinking back to our rule that the left side will always equal the right side, there’s a more specific rule that will always be true:

Assets = Liabilities + Owners’ Equity

This equation will always be true, again, as long as the numbers have been entered correctly…

Write this equation down, stamp it in your brain, or do whatever it takes to remember it. The best way to remember it is to just take a minute and think it through and understand what it means. It’s essentially saying that whatever assets we have on the left side, they have to be accounted for as either owed to another party, or owned by the company. In your case, of the $400 you have in assets, you own $300 and you owe the other $100 to your dad because he gave you the loan.

Now, we mentioned it before, but this document where you keep track of the assets, liabilities, and owners’ equity is called the balance sheet.

The Balance Sheet

The balance sheet consists of 3 parts:

  • Assets
  • Liabilities
  • Owners’ Equity

Assets are the things the company owns. These are things such as cash, accounts receivable, inventory, prepaid insurance, prepaid rent, and goodwill. There are basically two classifications of assets; current assets and fixed (or long-term) assets. Current assets are assets that will be used within one year. Current assets include cash, accounts receivable, inventory, prepaid insurance, and prepaid rent. There are other types of current assets, but those are the most common. Fixed assets are assets that will be around for longer than one year. Fixed assets include buildings, equipment, goodwill, and land. Asset accounts have a debit balance.

Liabilities are the obligations that a company has to repay. A liability could be amounts owed to a creditor, or to a vendor for supplies and inventory. Some examples of liability titles that you’ll see are notes payable, accounts payable, wages payable, interest payable, income taxes payable, bonds payable, and unearned revenue. An easy way to spot a liability is anything that has the word “payable” in it. This obviously means an amount that still has to be paid, and will always represent a liability. Another type of liability is when a company receives payment for a product or service that they haven’t delivered yet. This is called unearned revenue. Like assets, liabilities are also classified into both current and long-term liabilities. The same rules apply: a current liability is an obligation that has to be repaid within one year, and a long-term liability is an obligation that doesn’t need to be repaid within a year. Liability accounts have a credit balance.

Owners’ equity, or stockholders’ equity is basically the portion of the assets that the owners of the company own. Since assets=liabilities+owners’ equity, the assets of the company are either owned by someone external such as a creditor, or they are owned by the owners of the company, usually in the form of stockholders. The account titles in the owners’ equity portion of the balance sheet are usually common stock, preferred stock, paid-in capital in excess of par, and retained earnings. Owners’ equity accounts have a credit balance.

Alright, back to business… Since your pops loaned you the $100, you go ahead and pick up the lawn mower you want. We now have to make a change to the balance sheet:

balance sheet example

Did you catch the change? It’s not a huge difference, but it’s important. Since you bought the lawn mower with your $400, we account for it by adding another account to the balance sheet called “equipment”. That’s where we keep track of our $400 lawn mower. Notice that Cash is now at $0 and Equipment is at $400.

Moving on… You’re so excited about your new mower that you can hardly stand it. When you get home you can’t wait to show your mom your first business purchase. She brings up a potential problem, though… “How are you going to pay for gas for your new mower if you spent all of your money?” You hadn’t thought that far ahead… Well, your dad had no problem giving you a loan, so maybe your mom won’t either. After some more convincing and explaining(you’re getting better at it), your mom gives you a loan of $50. AWE-SOME!!

But again, you need to update your balance sheet:

balance sheet example

You added the $50 to your cash account, and you also added the $50 to the notes payable account because it’s a loan from your mom. The next thing you need to do is get some gas so that you can start mowing lawns. So you go down to the gas station and you fill up a 5 gallon jug of gas so that your mower has fuel. The gas cost $15. So, where does the gas go on your balance sheet? It’s not cash, and it’s not equipment… It goes to an account called “Inventory”. Inventory is the account that tracks the supplies a business uses to perform its services. In your case you’ll use the fuel in your mower to mow lawns. Here’s what it will look like on your balance sheet:

balance sheet example

Cash went down by $15 to $35, and now the Inventory account shows $15, which of course is the gas you bought. Notice that nothing changed on the right side of the balance sheet. Not every transaction will affect both the left and right sides… all that matters is that the left and right sides balance, which they still do after this transaction.

Now you need to decide how much you’re going to charge for your services. Since you only own a lawn mower at this point, the only service you can really offer is a basic mowing. That’s ok, there’s plenty of willing customers who don’t need a professional landscaper. You estimate that the average lawn will cost you about $2 in gas. For right now we won’t worry about trying to figure out the cost of the time it takes you to mow each lawn. Your time isn’t infinite however, so you do need to make it worth your while. You decide that you’ll charge $10 per lawn. That will leave you with a profit of $8 per lawn (10-2=8). Since you already know how to mow a lawn (you’ve been doing your parents’ for years now), and you have your mower, now all you need is some customers. Since you don’t have a big marketing budget, you decide to just go ask a few of your neighbors if they want your service.

At the end of your first week, you mowed 5 lawns… success! That means you brought in $50 in sales! But, you know that it cost you $2 per lawn in gas, for a total cost of $10 in gas. The official name for this cost is “Cost of Goods Sold”. What’s left over is called your “Gross Profit”. Here’s what it looks like:

accounting101.org balance sheet

This will also change your balance sheet… First, all $50 of your sales will be added to cash. But, you used $10 in gas, which reduces your inventory account by $10. If you stop there, the two sides of your balance sheet won’t balance, the left side will be $40 more than your right side. So you have to do one other thing… You need to account for the $40 somehow on the right side of the balance sheet. It won’t go under “notes payable” since it wasn’t a loan, and it won’t go under “original investment” because it came after the original investment… so where does it go? It goes to an account called “Retained Earnings”. Retained Earnings is part of Owners’ Equity (since you earned the money), and it is a running total of your company’s earnings over time. Here’s how your balance sheet will look now:

accounting101.org balance sheet example

Hopefully, this balance sheet example helped you understand how a balance sheet works a little better. Here are the main things you should remember:

The left and right sides of the balance sheet will always balance… that’s why it’s called a balance sheet!

The equation is: Assets = Liabilities + Owners’ Equity

In this lesson, we changed the balance sheet every time something happened…. in a real business you don’t do that- it’s too much work. There’s a whole section of accounting dedicated to tracking and recording the day-to-day transactions of a business, and we’ll get to that in another lesson.

In the next lesson, we’re going to learn about another financial statement that businesses use to track transactions over a period of time… it’s called the Income Statement. Again, a balance sheet is like a picture, or a snapshot in time. The income statement is more like a movie, or a record of things happening over a period of time.

 

If you found this helpful, please click the “like” button below to share it with others. Thanks!

9 Comments

  • Rachel Thompson

    Reply Reply May 24, 2012

    This was indeed helpful. It was plain and simple. Thank you so very much.
    RFT

  • shahid

    Reply Reply July 12, 2012

    Very good, step by step. It really helped me. Thanks a lot.

    Best regards,

    Shahid

  • Nevonie

    Reply Reply September 1, 2012

    It really helping me, thanks……..

  • Mark

    Reply Reply October 1, 2012

    Thank You for this – But there is a Mistake

    If Gross Proift it $40 and The cash WAS $35 Wont the Cash then be $75 not $85 ?

    Thank You

    • Amogh

      Reply Reply January 27, 2013

      Dear Mark,

      Same mis-understaing by me, but here is the solution.

      you need to add sales($50) in the cash and need to deduct cost of goods from inventory(10$)

      Cash 35+50(sales) = 85
      Inventory 15-10(cost of goods) = 5
      Equipment = 400

      total = 490.

  • mohsin

    Reply Reply January 31, 2013

    thanks

  • Alex

    Reply Reply May 30, 2014

    Thanks, great explanation! I needed to learn basics quickly and it was very helpful!

  • David

    Reply Reply October 3, 2014

    Very helpful introduction. Thanks!

    • Nate

      Reply Reply October 10, 2014

      You’re welcome David- thanks for reading.

Leave A Response

* Denotes Required Field