# The Balance Sheet

Business I · Accounting I · https://tryals.app/learn/business-i/the-balance-sheet

## The Balance Sheet Snapshot

The **balance sheet** is a financial photograph showing what a firm owns, owes, and leaves for owners **at a single date**. It always balances via $\text{Assets} = \text{Liabilities} + \text{Equity}$. Defintionally wrong if it fails.

**Assets** use two liquidity buckets:
- **Current assets**: cash or items converting within one year, ordered most liquid first.
- **Non-current assets**: long-lived resources, PP&E, and intangibles carried at cost minus **net book value**.

**Liabilities** use two timing buckets:
- **Current liabilities**: obligations due within one year.
- **Non-current liabilities**: obligations beyond one year.

**Equity** holds **share capital**, **retained earnings** (profits minus dividends), and reserves.

| | Current | Non-current |
|---|---|---| 
| Assets | Cash, inventory | PP&E, intangibles |
| Timeline | Within one year | Beyond one year |
| Ordered by | Liquidity | Useful life |

**Golden Rule**: The statement must always balance.

## Reading the Skeleton

Read the balance sheet in fixed order: **Size**, **Asset mix**, and **Financing mix**. Compare mix against industry norms, as an airline's PP&E differs from a consultancy's receivables.

$$\text{Current ratio} = \frac{\text{Current assets}}{\text{Current liabilities}} \qquad \text{Leverage} = \frac{\text{Total liabilities}}{\text{Total equity}}$$

**Net working capital** is current assets minus current liabilities. Negative working capital can work for supermarkets selling inventory before paying suppliers, but usually signals cash strain.

**Retained earnings** shows lifetime profit left inside. Large balances show self-financed growth.

> **Common pitfall**: Comparing asset mixes across different industries. Always judge a firm against its peers.

## Practice questions

7 of this lesson's 13 practice questions, with answers. The full set is in the app.

### 1. A firm with negative net working capital is always insolvent.

**Answer:** False

**Why:** Negative working capital means current liabilities exceed current assets, but it does not mean insolvency. Supermarkets routinely run negative working capital, they sell inventory for cash before they must pay suppliers. Context determines whether the negative is dangerous or deliberate.

Page: https://tryals.app/practice/business-i/the-balance-sheet/a-firm-with-negative-net-working-capital-is-always-insolvent

### 2. Current or non-current? Classify each item.

**Answer:**

- Current asset: Inventory, Accounts receivable
- Non-current asset: A patent, Factory buildings
- Current liability: Trade payables due in 30 days
- Non-current liability: A ten-year bond

**Why:** The one-year line divides both sides: above it, items cycle within the operating period; below it, commitments span multiple years.

Page: https://tryals.app/practice/business-i/the-balance-sheet/current-or-non-current-classify-each-item

### 3. Match each balance-sheet ratio to what it measures.

**Answer:**

- Current ratio → Can the firm pay its short-term bills?
- Debt-to-equity → How much creditor money per euro of owners' money?
- Net working capital → The short-term liquidity cushion
- Net book value → An asset's cost minus accumulated depreciation

**Why:** Four numbers, four questions, liquidity, leverage, cushion, and asset wear.

Page: https://tryals.app/practice/business-i/the-balance-sheet/match-each-balance-sheet-ratio-to-what-it-measures

### 4. A supermarket chain runs with negative working capital year after year and is perfectly healthy. How?

A. Supermarkets are exempt from normal liquidity requirements
B. It collects instantly and pays suppliers on 60-day terms
C. It is not healthy; the position is being disguised by accounting choices
D. Its inventory is valued below cost, which understates current assets

**Answer:** B. It collects instantly and pays suppliers on 60-day terms

**Why:** Cash arrives before the supplier invoice falls due, so the suppliers finance the inventory and the ratio reads as a strength inverted. It is why liquidity ratios must be read against the business model, the same number that would alarm you at a shipbuilder is normal at a grocer.

Page: https://tryals.app/practice/business-i/the-balance-sheet/a-supermarket-chain-runs-with-negative-working-capital-year-after

### 5. A company has current assets 80 and current liabilities 110. What does this tell us?

A. The balance sheet does not balance
B. The firm is profitable
C. Total equity is negative
D. Negative working capital

**Answer:** D. Negative working capital

**Why:** Working capital is $80 - 110 = -30$. The firm cannot cover all short-term bills from short-term assets alone, it needs either new financing or fast cash generation.

Page: https://tryals.app/practice/business-i/the-balance-sheet/a-company-has-current-assets-80-and-current-liabilities-110-what

### 6. Which items belong in the equity section of the balance sheet?

A. Share capital
B. Accounts payable
C. Retained earnings
D. Revaluation reserves

**Answer:** A. Share capital; C. Retained earnings; D. Revaluation reserves

**Why:** Share capital (what owners put in), retained earnings (profits left inside), and reserves (revaluations, other comprehensive income). Accounts payable is a liability, a creditor claim, not an owner claim.

Page: https://tryals.app/practice/business-i/the-balance-sheet/which-items-belong-in-the-equity-section-of-the-balance-sheet

### 7. Order balance-sheet items from most liquid to least liquid.

**Answer:**

1. Cash
2. Accounts receivable (30 days)
3. Inventory
4. Equipment
5. Land

**Why:** Cash is already liquid; receivables convert in weeks; inventory must be sold; equipment must be sold second-hand; land is the slowest to liquidate. Balance sheets list current assets in this order.

Page: https://tryals.app/practice/business-i/the-balance-sheet/order-balance-sheet-items-from-most-liquid-to-least-liquid