The Mathematics of Money

Copyright © 2008, The McGraw-Hill Companies, Inc.

Basic Balance Sheets

A balance sheet is a financial statement that is intended to show a snapshot of a business’s

assets (what the business owns), liabilities (what the business owes), and (owner’s) equity

or net worth (the difference between the two). The balance sheet can be summed up with

the equation:

Equity  Assets 
 Liabilities

This form of the equation is probably the most intuitive way of expressing the relation-

ship. A mathematically equivalent expression of this relationship can be found by adding

liabilities to both sides of this equation. This alternative form is more commonly used in

accounting:

Assets  Liabilities  Equity

Example 12.2.1 A business has total assets of $1,503,055 and total liabilities of

$932,055. What is the owners’ equity?

Working from the fi rst form of the balance sheet equation gives:

Equity  $1,503,055 
 $932,055  $571,000.

We could also have got this from the second form with just a bit of algebra:

Assets  Liabilities  Equity

$1,503,055  $932,055  Equity

Equity  $571,000

Example 12.2.2 A corporation reports that its assets total $20,500,000 and its

stockholders’ equity is $4,000,000. What are the corporation’s total liabilities?

Since the stockholders are the owners of the corporation, the term stockholders’ equity is

understood to mean the same thing as owners’ equity. Working from the second form of the

balance sheet equation gives:

Assets  Liabilities  Equity

$20,500,000  Liabilities  $4,000,000

Liabilities  $16,500,000

It would also be possible to get this from the fi rst form of the equation, but the algebra is a

bit more involved.

Just as with income statements, these broad categories may be listed out in some detail.

Some of the more common terms used for this breakdown are defined below.

Balance sheets are commonly set up in two columns. One column lists the assets of the

business, the other lists the liabilities and equity. Since assets  liabilities  equity, the

totals of these two columns should be the same. They can be thought of as two sides of a

balanced scale (hence the name balance sheet).

Here is a very simple example of a balance sheet for the company from Example 12.1:

Basic Example Corporation

Balance Sheet as of December 31, 2007

Assets Liabilities

Assets $500,000 Total liabilities $350,000

Equity

To tal equity $150,000

To tal assets $500,000 Total liabilities and equity $500,000

12.2 Balance Sheets 499