Understanding Balance Sheets      

A business-English activity

Madrid resident Ivan Garth writes his first business English article for students on MadridTeacher.com. Do the activity first here: Activity (the vocabulary list is at the bottom of this page). Alternatively, listen to the WAV or MP3 sound file and read the article below.

  

Understanding Balance Sheets

There are three key financial statements that are necessary for analysing businesses. This analysis may be to aid investment decisions of potential investors, aid investment decisions to be made by the actual company or even potential lenders that need to decide whether to trust their money in the company amongst other reasons.
For example, shareholders use these statements to know how their money is doing and the management of the company needs these statements to understand how the company is working, its evolution and measure the company's achievements.

These three statements are:

Balance Sheet - this tells us what a company has, owes and what's left for the owners.
Income Statement - this tells us how much a company is making; its profitability.
Cash Flow Statement - this tells us where the money has gone.

The above explanation is true but is over-simplified as these three financial statements can tell us a great deal about the company and even more so, if you have statements from two or more financial periods.

What we are going to do today is explain the Balance Sheet. The Balance Sheet is a snapshot of the company's financial condition at any one moment in time, usually at the close of a financial period. Normally, two balance sheets at two different moments are presented; this gives us extra information as it also allows us to understand how the company's financial condition has evolved. But let me explain what a Balance Sheet is in very simple day-to-day terms. Imagine you need a loan to buy a new car. The bank manager asks you to provide him with your financial situation, so you go home and sit in front of a blank piece paper, a pen, those dusty financial documents and you divide the page in two, writing everything you have on one side, such as your house, investments, etc. with their corresponding value and on the other what you owe, e.g. your mortgage. The difference between the two sides is your net wealth. Well, this is your personal Balance Sheet and companies do the same...

So, getting back to a more technical explanation, a Balance Sheet has three main areas - assets, liabilities and shareholder's equity and these must keep to the accounting equation:

So as its name suggests the Balance Sheet must balance, but... What do these three elements mean?

Assets are economic resources that are expected to produce economic benefits for its owners. Assets can be buildings and machinery used to manufacture products. They can be patents or copyrights that provide financial advantages for their holder or even money owed to them by their customers.

Liabilities are obligations a company owes to outside parties. They represent rights of others to money or services of the company. Examples include bank loans, debts to suppliers or to employees.

Shareholders' equity is the value of a business to its owners after all of its obligations have been met. This net worth (the difference between what it owns and what it owes) belongs to the owners. Shareholders' equity generally reflects the amount of capital the owners invested plus any profits that the company generates that are subsequently reinvested in the company. This reinvested income is called retained earnings.

Those of you less familiar with financial statements are probably wondering what a typical Balance Sheet looks like, so take a look below:

In the example you can see the three big areas of the Balance Sheet and how these actually balance. You can also see that each area can be broken down into various other smaller elements, but these I will explain another day...

Vocabulary

Practice this vocabulary: Balance Sheets Vocabulary

key financial statements - estados financieros claves
aid - ayuda
investors - inversores
investment - inversiones
decisions to be made - decisiones a tomar
by the actual company - por la propia empresa
potential lenders - prestamistas potenciales
amongst other reasons - entre otras razones
measure the company's achievements - medir los logros de la empresa
Balance Sheet - Balance
owes - deber
owners - propietarios
Income Statement (Profit & Loss Account) - Pérdidas y Ganancias
profitability - rentable
Cash Flow Statement - Estado de origen y aplicación
a great deal - mucho
even more so - aún más
snapshot - foto
A financial condition - estado financiero
the close of a financial period - cierre de un ejercicio contable
loan - préstamo
bank manager - director de banco
financial situation - estado financiero
value - valor
net wealth - patrimonio neto
getting back - volviendo
assets - activos
liabilities - exigible
shareholder's equity - fondos propios
balance - cuadrar
economic resources - recursos económicos
buildings - edificios
machinery - maquinaria
to manufacture products - fabricar productos
outside parties - partes externas
rights of others to money - derechos de otros a dinero
debts to suppliers - deudas con proveedores
employees - empleados
have been met - han sido cubiertas
net worth - patrimonio neto
belongs - pertenece
profits - beneficios
retained earnings - beneficios acumulados años anteriores
actually balance - efectivamente cuadra
broken down - desglosado