Does a Balance Sheet Measure Profitability?

by Jeff Franco

There are a variety of financial statements that companies prepare to report profitability, financial leverage, cash flow positions and asset holdings. The balance sheet, however, doesn't provide insight into the profitability of a company. Rather, it provides investors and creditors with the balance of the company's assets, liabilities and owners' equity. The income statement, on the other hand, is the appropriate financial statement to report a firm's profitability.

Balance Sheet Equation

If you are unfamiliar with the layout of a typical balance sheet, it's imperative that you first understand the underlying equation behind its presentation. As the name implies, there must be a balance between the assets and the sum of liabilities and equity (A = L + E). The reasoning behind this equation is that all asset financing must either come from funds the company borrows, which is a liability, or from the owners and investors of the company, which companies report as equity.

Reporting Asset Categories

In the financial accounting world, the asset section of the balance sheet covers two broad categories of assets: current and non-current. Current assets include a company's cash balance in the bank, stocks and bonds it purchases as investments that are easily converted into cash, plus all other property, such as materials and supplies, it anticipates depleting within one year of purchase. In contrast, the non-current assets represent property the company anticipates holding for many years that are not easily converted into cash. This includes the furniture and computer in company offices, buildings and land, and the equipment it uses in the business. Regardless of the asset category, the balance sheet always reports the asset's purchase price, irrespective of its fair market value.

Reporting Liabilities

The liabilities side of the balance sheet includes all debts that the company has. And just like assets, companies classify each one as current and non-current. A current liability is any debt that is due within one year. These can include unpaid invoices from suppliers, short-term borrowings and the interest they accrue but have not yet paid. Non-current liabilities on the balance sheet reflect the outstanding balances of debts the company has more than one year to fully satisfy. Generally, this includes the company's future bond redemptions and long-term promissory notes.

Reporting Equity

The equity section of the balance sheet reports all remaining sources of financing other than debt. If the company is a corporation, the equity section reports the capital it raises from shareholders. However, if the firm uses a non-corporate structure, it will still report all cash and property contributions that owners and investors make. In addition, companies report retained earnings in the equity section. The retained earnings account balance accumulates the net income a company reports each year on its income statement, but decreases for the dividend payments or distributions the company makes to shareholders and investors.

About the Author

Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.

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