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Figure 2-2 shows the building blocks of a typical balance sheet for a business that sells products and services on credit. As mentioned, one reason the balance sheet is called by this name is that its two sides balance, or are equal in total amounts. In this example, the $27.172 million total assets equals the $27.172 million total liabilities and owners’ equity. The balance or equality of total assets on the one side of the scale and the sum of liabilities plus owners’ equity on the other side of the scale is expressed in the accounting equation, which we discuss in Chapter 1. Note: The balance sheet in Figure 2-2 shows the essential elements in this financial statement. In a financial report, the balance sheet includes additional features and frills, which we explain in Chapter 7.

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FIGURE 2-2: Balance sheet information components for a technology business that sells products and services on credit.

Take a quick walk through the balance sheet. For a technology company that sells products and services on credit, assets are reported in the following order: First is cash, then receivables, then cost of products held for sale, and finally the long-term operating assets of the business. Moving to the other side of the balance sheet, the liabilities section starts with the trade liabilities (from buying on credit) and liabilities for unpaid expenses. Following these operating liabilities is the interest-bearing debt of the business. Owners’ equity sources are then reported below liabilities. So a balance sheet is a composite of assets on one hand and a composite of liabilities and owners’ equity sources on the other hand.

A balance sheet is a reflection of the fundamental two-sided nature of a business (expressed in the accounting equation, which we discuss in Chapter 1). In the most basic terms, assets are what the business owns, and liabilities plus owners’ equity are the sources of the assets. The sources have claims against the assets. Liabilities and interest-bearing debt have to be paid, of course, and if the business were to go out of business and liquidate all its assets, the residual after paying all its liabilities would go to the owners.

A company that sells services doesn’t have an inventory of products being held for sale. A service company may or may not sell on credit. Airlines don’t sell on credit, for example. If a service business doesn’t sell on credit, it won’t have two of the sizable assets you see in Figure 2-2: receivables from credit sales and inventory of products held for sale. Generally, this means that a service-based business doesn’t need as much total assets compared with a products-based business with the same size sales revenue.

The smaller amount of total assets of a service business means that the other side of its balance sheet is correspondingly smaller. In plain terms, this means that a service company doesn’t need to borrow as much money or raise as much capital from its equity owners.

As you may suspect, the particular assets reported in the balance sheet depend on which assets the business owns. We include six basic types of assets in Figure 2-2. These are the hardcore assets that a business selling products or services on credit would have. It’s possible that such a business could lease (or rent) virtually all its long-term operating assets instead of owning them, in which case the business would report no such assets. In this example, the business owns these so-called fixed assets. They’re fixed because they are held for use in the operations of the business and are not for sale, and their usefulness lasts several years or longer.