Financial jargon can often feel like a foreign language, leaving many scratching their heads when trying to make sense of their money matters. Let’s break down some common financial terms and translate them into plain English.
Balance Sheet (Accounting) Terms
Assets
Assets are resources owned by a company that have economic value. They are typically divided into two categories:
- Current Assets: These are assets that can be converted to cash within one year. They include:
- Cash and cash equivalents: Money in the bank or highly liquid investments.
- Accounts receivable: Money owed to the company by customers.
- Inventory: Goods available for sale.
- Prepaid expenses: Costs paid in advance, like insurance or rent.
- Non-current Assets: These are long-term assets not expected to be converted to cash within a year. They include:
- Property, Plant, and Equipment (PP&E): Physical assets like buildings and machinery.
- Intangible assets: Non-physical assets like patents, trademarks, and goodwill.
- Long-term investments: Investments held for more than a year.
Liabilities
Liabilities are financial obligations or debts that a company owes to others. They are also divided into two categories:
- Current Liabilities: These are debts due within one year. Examples include:
- Accounts payable: Money owed to suppliers.
- Short-term debt: Loans due within a year.
- Accrued expenses: Costs incurred but not yet paid, like wages or taxes.
- Non-current Liabilities: These are long-term obligations due after one year, such as:
- Long-term debt: Loans or bonds with maturities beyond one year.
- Lease obligations: Long-term lease commitments.
- Deferred tax liabilities: Future tax obligations.
Shareholders’ Equity
Also known as owners’ equity, this represents the residual interest in the company’s assets after deducting liabilities. It includes:
- Share capital: Money invested by shareholders.
- Retained earnings: Profits reinvested in the business.
Key Concepts
Balance Sheet Equation
The fundamental equation underlying the balance sheet is:
Assets = Liabilities + Shareholders’ Equity
This equation must always balance, hence the name “balance sheet.”
Working Capital
This is the difference between current assets and current liabilities. It indicates a company’s short-term financial health.
Current Ratio
Calculated by dividing current assets by current liabilities, this ratio measures a company’s ability to pay short-term obligations.
Depreciation
This accounting method spreads the cost of a fixed asset over its useful life, affecting both the balance sheet (reducing asset value) and income statement (as an expense).
Conclusion
Understanding these terms and concepts helps in interpreting a company’s financial position and assessing its overall financial health.
