Reading: Accounting Framework

The balance sheet provides a snapshot of the firm's assets, liabilities, and equity. It shows who provided the firm's capital and how that capital is used. The basic structure of the balance sheet is as follows:

 Current assets: All assets that are reasonably expected to be converted into cash within 1 year. Examples: Cash, Inventory, Accounts receivable.

• Non-current assets: Assets which are expected to be in use for more than 1 year. Examples: Property, plant, and equipment, Goodwill, Patents, long-term deferred taxes.

• Operating liabilities: Money that is owed to business partners from transactions related to the actual production and sale of the firm's goods and services. Examples: Accounts payable, deferred taxes, provisions.

• Financial liabilities (Debt): Money that is owed to the providers of debt. Examples: Bank loan, Mortgages, Long-term debt.

• Equity: Capital contributed by the owners of the company (shareholders). Examples: Share capital, Retained earnings, Treasury shares (negative), Noncontrolling interests.

It is important to note that the balance sheet is an account of the past that summarizes the book value of the firm's assets, liabilities, and equity. This book value does not necessarily correspond to the market value of the firm's assets, liabilities, and equity, which is a forward-looking metric.

As an example of a balance sheet, consider the balance sheet of The Hershey Company, as reported in their SEC filings for the business year 2015 (Worksheet "Consolidated Balance Sheets"). Values are in thousands of USD:

The balance sheet follows the exact same structure as our template above, though it is a bit more complex. A few points are worth noting:

• At the end of 2015, the firm had total assets of 5.3 billion, of which 1.8 billion are expected to convert into cash within a year (current assets). These assets are financed with liabilities of 4.3 billion and equity of 1.0 billion.

• As a comparison, the market value of the firm's equity was approximately 19.4 billion billion at the end of 2015. We can find this number by multiplying the share price with the number of shares outstanding.

• With respect to the firm's liabilities of 4.3 billion, the following considerations are important:
• The balance sheet makes a distinction between current liabilities (payable within a year) and long-term liabilities (maturity in more than 1 year). The current liabilities (2.2 billion) account for a little more than half of the firm's total liabilities.
• Consistent with the template above, the balance sheet also allows us to distinguish between operating liabilities and financial liabilities (debt). 
• Operating liabilities arise from the firm's primary business operations and they are non-interest bearing. In the case of Hershey, the include the items Accounts payable, Accrued liabilities, Accrued income taxes, Other long-term liabilities, and Deferred income taxes.
• Financial liabilities arise from the firm's financing activities and are, in principle, interest bearing (under market conditions). In the case of Hershey, the include the items Short-term debt, Current portion of long-term debt, and Long-term debt.
• At the end of 2015, Hershey had operating liabilities of 1.9 billion and financial liabilities of 2.4 billion.

• Finally, a few words on the firm's equity.
• The equity part shows us how much capital the shareholders have paid in (and to what extent they have retained net income in the company).
• In 2015, common stock and paid-in capital amounted to 1.144 billion
• Retained earnings of 5.9 billion imply that, in the past, the firm has generated a total of almost 6 billion of net income that was not distributed to its shareholders in the form of dividends.
• The position "Treasury common stock" shows that, in the past, the firm has repurchased shares at a total cost of 5.7 billion. Compared to 2014, this position has increased by roughly 500 million. This implies that Hershey has repurchased shares at a cost of roughly 500 million in 2015. Firms often choose share repurchases over dividend payments for tax reasons.
• Finally, we se that the firm reports "Noncontrolling interests in subsidiaries." This is the portion of equity in the firm's subsidiaries that is not attributable to Hershiey because these subsidiaries have minority shareholders.

Let us now turn to the other key financial statement, the income statement.