Balance Sheet Terms

In a financial context the term current means within the present accounting period. Current assets are cash or those things which are expected to be turned into cash in this accounting period. The accounting period could be one month, one quarter, or, as in our example, one year.

The current accounts receivable item refers to monies that are owed to the corporation and expected to be paid in this accounting period. Any bills (invoices) that have been sent to customers but not yet collected would be included in this line item. As noted in the example, doubtful accounts are deducted from these. The longer someone goes without paying you, the more doubtful the account becomes. Without deducting these doubtful accounts, the financial strength of your business might be misrepresented.

Inventory represents a lot of physical items, although it is given as a monetary value on the balance sheet. There are several different kinds of inventory, such as raw materials (things you buy from suppliers, before you use them to make your products,) goods in process (partly completed,) finished goods, and other indirect supplies. Not all companies have all kinds of inventory. Inventory is often a major expense and is sometimes difficult to manage. There are various legal ways to cost inventory, and different inventory costing techniques can dramatically change a company's bottom line. With better technology, many corporations are using what is referred to as just-in-time inventory. Materials and parts are ordered just before they are needed for manufacturing, and arrive just as they are needed. This has saved millions of dollars of inventory costs.

You may have a lot of information about inventory and how well or poorly it is managed. It may be time to impact the bottom line with your suggestions.

We add the current assets together to come up with the total current assets figure, and then move on to noncurrent, or long-term, assets.

A corporation's property, plant, and equipment are considered assets, although they are not current assets since they are not easily converted to cash. The same long-term asset may be listed on the balance sheet with a different value each year because it has been depreciated, in the same way that your car is worth less each year you own it.

Financial reports must reflect what took place during a specified time frame. Otherwise, they wouldn't mean much. Some items, such as a building or a copy machine, last awhile. An attempt is made to reflect what portion of an item was "used up" during the accounting period in question (month, quarter, year.) A certain amount is allocated, regardless of what money (if any) was actually spent on the asset during the time frame. This used-up value is deducted from last accounting period's value to determine the value of the asset. There are three terms that describe the allocation: depreciation, amortization, and depletion.

Of the three terms, you probably see the term depreciation most often. This one is used in our example. This term applies to physical objects. Buildings, computers, and anything else expected to last beyond a year or so are usually depreciated. The IRS dictates the length of time over which we can depreciate an item, based on an estimated life for items in the same category. The length of time is shorter for items like computers that quickly become obsolete, than for items such as buildings that are expected to be used for a longer time. Legally, some items must be depreciated in a certain way. For other things, a company has a choice of ways to depreciate the item. The choice can affect the reported bottom line. These are decisions for the accountant.

The allocation is called amortization when it refers to an intangible item. If you hold a patent on a product, for example, you will "use up" a part of this patent during each quarter and each year until it expires. The value of the patent is determined and then amortized over the life of the patent. For each accounting period, a portion (not necessarily equal portion) of this value shows up as an amortization allowance. You are gradually using up something of value. This does not actually cost the company money, but it appears as an expense. It is a deduction from revenues, therefore decreases the company's tax liability.

A depletion allowance is used for natural resources that a corporation owns. For example, it may be estimated that a certain oil well will produce oil for 20 years, and this asset (the well) will be depleted over that time. If you are still pumping oil from the well after 20 years, you will have no depletion allowance to deduct from your revenues. If the well is still producing enough, you probably will not shut it down, but you will no longer have a depletion allowance to offset the revenue. You will pay taxes accordingly.

Unless you are an accountant, you will not need to determine these allocations. You may never hear of them again, but you might. Because they represent deductions from revenues and may be far different from actual cash expenditures, they have an impact on the cash flow of your company. For instance, if you pay $700,000 cash in 1999 for a new robotic system, that capital will not be available for other purposes. According to the income statement, however, you will have an expense that is far less than $700,000. It might be important for you to know where these figures came from.

Returning to the balance sheet example, we add all our assets, both current and long-term, together and compare them to our liabilities.

Liabilities are those items that we have not spent money on yet, but we know we will. Current liabilities are those obligations payable within the accounting period in question. They must be paid soon. As our year ends, we have some bills we have not paid. These are accounts payable, or A/P.

In our example, ABC Corporation has an obligation to pay some employees for time and benefits, so these are listed under accrued expenses. In other words, some people have put in time that has not been paid for. Even if they have already quit, the expense has been incurred, and they will have to be paid. In addition, there is income tax owed, perhaps for the fourth quarter, which has yet to be paid. There is a difference in timing between when taxes are due and when the accounting period ends. It is advantageous to hold onto our money as long as possible and pay things only as they are due, but we must list those obligations we have.

We add these together to get total current liabilities.

The next line item in the example shows our long-term obligations, which are the dollars we have committed to pay over a long-term contract, such as the lease on a building or equipment. We haven't paid this money yet, but to leave it off the balance sheet would misrepresent the financial strength of the company. That money is not available to be used for anything else.

Our liabilities are added together, and the difference between the assets and liabilities is the stockholder's equity. This is an oversimplification, but this is one way to measure the value of the corporation at a given time.

You may not be reading financial reports on a regular basis, but you may hear and use these terms in a business setting. Become familiar with the terms used in your company and your industry. Your intelligent use of financial terms will help others take you more seriously and see you for potential beyond your current position.