This chapter focuses solely on the balance sheet, which is often called the statement of financial position. At any given date, the balance sheet shows the sources from which the firm has obtained its resources and the ways in which those resources are currently employed. Recall the basic accounting equation:
ASSETS + LIABILITIES = OWNERS’ EQUITY (capital)
Another way to state this relationship is
Uses of resources = Sources of resources
assets + liability = capital () owners’ equty
In other words, liabilities and owners’ equity are the sources from which the firm has obtained its funds, and the listing of assets shows the way in which the firm’s managers have put those funds to work.
Another useful way to view the balance sheet is as the cumulative result of the firm’s past activities. Liabilities represent the total amount the firm has borrowed during its existence, minus the amounts that have been repaid to date. The owners’equity items show the total amount invested by owners, plus the total profits earned by the firm during previous periods, minus any amounts that have been distributed to owners. Similarly, the assets of the firm represent the total resources obtained by the firm from lenders and owners, minus those that have been consumed in the firm’s operations, repaid to lenders, or distributed to owners.