Balance Sheet

A balance sheet is a financial statement that shows what an organization owns, what it owes and what is left over for its owners on a particular date. It is one of the three core financial statements, alongside the income statement (which reports profit over a period) and the cash flow statement (which tracks cash flow). Under International Financial Reporting Standards it is formally called the statement of financial position.

Companies, banks, central banks, governments and even households can draw up a balance sheet. Investors, lenders, regulators and rating agencies read it to judge solvency, liquidity and how a business is financed. Listed companies publish one at least annually, and usually every quarter or half-year, prepared under IFRS or national standards such as US GAAP and checked by an independent auditor. Before the figures are published, accountants carry out balance sheet reconciliation, checking each asset, liability and equity account in the ledger against independent evidence such as bank and loan statements.

Imagine taking a photograph of a household's finances on New Year's Eve. On one side of the picture is everything it owns: the house, the car, savings and a pension pot. On the other side is everything it owes, such as the mortgage and a credit card bill, plus whatever is left after those debts, which is the family's own stake.

The two sides always match, because whatever the household owns was paid for either with borrowed money or with its own money. A balance sheet is that photograph for a business. It does not show how busy the year was, only where things stand at one moment.

Every balance sheet rests on a single identity:

• $\text{Assets}$ are the resources the organization controls, described in the asset entry.
• $\text{Liabilities}$ are its obligations to others, covered in liabilities.
• $\text{Equity}$ is the residual claim of the owners, equal to assets minus liabilities, and is the company's book value.

Worked example: a small manufacturer holds $40,000 in cash, $60,000 of inventory and machinery with a carrying value of $300,000, so total assets are $400,000. It owes $50,000 to suppliers and $150,000 on a bank loan, giving liabilities of $200,000. Equity is therefore $400{,}000 - 200{,}000 = 200{,}000$ dollars. Because of double-entry bookkeeping, every transaction changes at least two lines and keeps the equation true; buying a $10,000 machine on credit raises assets and liabilities by the same amount.

A typical corporate balance sheet lists:

• Non-current assets. Property, plant and equipment shown net of depreciation, an intangible asset figure that often includes goodwill from acquisitions, and long-term investments.
• Current assets. Inventory, trade receivables, short-term investments and cash.
• Current and non-current liabilities. Payables, borrowings, lease liabilities, provisions and deferred tax.
• Equity. Share capital, retained earnings built up from past profits and other reserves.

Analysts turn these lines into ratios. Working capital is current assets minus current liabilities; the current ratio divides the two; gearing compares debt with equity; and the price-to-book ratio compares the market's valuation with balance-sheet equity. Because many assets are recorded at historical cost and internally created brands are usually omitted, the balance sheet is a starting point for valuation rather than a market price.

A bank's balance sheet looks different. Its assets are mostly loans, securities and reserves at the central bank; its liabilities are mostly deposits and wholesale funding; and its equity forms the core of bank capital. Regulators under Basel III set minimum capital and liquidity ratios based on that balance sheet. A bank funds long-term loans with short-term deposits, which is why a sudden loss of confidence can turn into a liquidity crisis.

Central bank balance sheets became a policy tool after the 2008 financial crisis. Through quantitative easing, the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan bought large amounts of bonds, and their balance sheets grew several-fold. Reversing that through quantitative tightening shrinks them again. Commentators therefore speak of central bank "balance sheet policy" alongside interest rate policy.

Some exposures do not appear on the face of the balance sheet. Before 2008, banks moved assets into special-purpose vehicles linked to securitization that later had to be taken back, and companies kept many leases off the books until IFRS 16 and ASC 842 took effect in 2019. Guarantees and pending lawsuits are often shown only in the notes.

At the level of a whole economy, the economist Richard Koo used the term "balance sheet recession" for Japan in the 1990s: after asset prices collapsed, firms and households focused on repaying debt rather than spending, even with very low interest rates. The idea is used to explain why recessions that follow property or credit bubbles can be long and why negative equity weighs on household spending.

• IFRS Foundation: IAS 1 Presentation of Financial Statements
• IFRS Foundation: IFRS 18 Presentation and Disclosure in Financial Statements