Balance Sheet: Total Assets = Total Liability + Total Equity
Yes, this was very strange for me as well when I first saw the formula of total assets equal to the sum of total liability and total equity. Don't worry, a example below will help you have a better understanding about the role of balance sheet in a company.
Example:
At the beginning of year 0:
After Company X is listed with market price of $1000 and number of shares of 1000 or $1 per share. Besides, let's say that company X used this money to buy a plant of $ 200.00 and goods of $200.00. Next, this company makes a long term borrowing of $200.00 from bank with instalment $50.00 per year.
The balance sheet of company X at the beginning of year 0 is shown below:
| Non-Current Assets Property, plant and equipment: $ 200.00 Current Assets Inventory : $200.00 Cash and cash equivalents: $ 800.00 Total Assets: $1200.00 | Non-current Liabilities Long term borrowing : $200.00 Total Liabilities: $200.00 Equity Share capital: $ 1000.00 Total Equity: $ 1000.00 |
At the beginning of year 1:
After one year, let's assume the company has sold out $100.00 goods with net profit of $50.00. But only $30 has been received and the remainder become a receivable payment with a period of one year . Besides, in order to expand this business, company have brought new plant which costs $200.00 by using their cash. Furthermore, company X decides to increase $400 to its inventory since company X has higher expectation in incoming year. But this time, company only pay 50% to its creditor.
Therefore, the balance sheet at the beginning of year 1 become:
| Non-Current Assets Property, plant and equipment: $ 400.00 Current Assets Inventory : $500.00 ($100 + $400) Accounts receivable: $120.00 Cash and cash equivalents: $ 430.00 Total Assets: $1450.00 | Non-current Liabilities Long term borrowing : $150.00 Current Liabilities Short term borrowing: $50.00 Accounts payable: $200.00 Total Liabilities: $400.00 Equity Share capital: $ 1000.00 Retained Profit: $ 50.00 Total Equity: $ 1050.00 |
Adding inventory of $400 = $200(cash) + $200(payable)
Selling Profit ($50) + cost ($100) = $150 = Received Cash of $30 + Receivable of $120
Cash equivalents = $800 + $30 - Increase of inventory ($400) = $430
Note: $50 from long term borrowing is shift to current liabilities. At the beginning of year 2:
Company X has successfully sold its goods with cost of $300.00 and profit of $200.00. However, the company is required to clear its current liabilities now. And assuming the company has successfully received all receivable from its customers. But in this period, up to $300.00 haven't been received from its customers.
Therefore, the balance sheet at the beginning of year 2 become:
| Non-Current Assets Property, plant and equipment: $ 400.00 Current Assets Inventory : $200.00 Accounts receivable: $300.00 Cash and cash equivalents: $ 500.00 Total Assets: $1400.00 | Non-current Liabilities Long term borrowing : $100.00 Current Liabilities Short term borrowing: $50.00 Accounts payable: $0.00 Total Liabilities: $150.00 Equity Share capital: $ 1000.00 Retained Profit: $ 250.00 Total Equity: $ 1250.00 |
Inventory : $500 - selling cost of $300 = $200.00
Cash equivalents: $ 500 = $ 430 + received cash from selling of $200 + previous receivable of $120 - payable of $200 - borrowing installment of $50 Retained Profit: $ 250 = previous profit of $50 + current profit of $200
Now, the company has decided to reward their investors with dividend of $0.10 per share or total amount of $100.00. Since the dividend is paid by cash, both amount in Cash and cash equivalent and Retained profit is deduced for this dividend issue.
Therefore, the balance sheet at the end of year 2 become:
| Non-Current Assets Property, plant and equipment: $ 400.00 Current Assets Inventory : $200.00 Accounts receivable: $300.00 Cash and cash equivalents: $ 400.00 Total Assets: $1300.00 | Non-current Liabilities Long term borrowing : $100.00 Current Liabilities Short term borrowing: $50.00 Accounts payable: $0.00 Total Liabilities: $150.00 Equity Share capital: $ 1000.00 Retained Profit: $ 150.00 Total Equity: $ 1150.00 |
As you can see, Total Assets = Total Liability + Total Equity. That's why we always say balance sheet must always BALANCE. Feel free to give me a comment about this topic. It will be a great support to Xaivier Blog.
Written by: Xaivier Chia
First edited at Oct 2010
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