What Is a Financial Position Statement?

The statement of financial position offers a snapshot of a company’s financial health at a specific moment and is more commonly known as the balance sheet. This document provides a structured summary of what a company owns and what it owes. The statement is prepared on a particular date, such as the end of a quarter or a fiscal year, to present a picture of the company’s financial standing. Publicly traded companies are required to prepare these statements to comply with Generally Accepted Accounting Principles (GAAP), ensuring transparency for investors, creditors, and regulators.

The Core Equation of Financial Position

At the heart of the statement of financial position is the formula: Assets = Liabilities + Equity. This accounting equation dictates that a company’s total assets must equal the sum of its total liabilities and its owners’ equity. Assets are the economic resources owned by the company. Liabilities are the company’s obligations or debts owed to other parties. Equity represents the residual interest in the assets after deducting all liabilities; it is the stake belonging to the owners.

To understand this, think about buying a house. The house is an asset, the mortgage is a liability, and the homeowner’s equity is the portion of the house’s value that they own outright, which is the value of the house minus the outstanding mortgage balance. The statement of financial position applies this same logic to a business. The document is called a balance sheet because the two sides must always be equal. This balance provides a check for accuracy, as a mismatch signals an error in the accounting records.

A Breakdown of Assets

On the statement of financial position, assets are categorized based on their liquidity, or how easily they can be converted into cash. The two classifications are current assets and non-current assets.

Current Assets

Current assets are all assets expected to be sold, consumed, or converted into cash within one year.

• Cash is the most liquid asset and includes currency, bank balances, and short-term investments with a maturity of 90 days or less.
• Accounts receivable represents money owed to the company by its customers for goods or services already delivered but not yet paid for.
• Inventory is the value of goods available for sale.
• Prepaid expenses are payments made in advance for future goods or services, such as insurance premiums or rent.

Non-Current Assets

Non-current assets, also known as long-term assets, are resources not expected to be converted into cash within one year. Property, Plant, and Equipment (PP&E) is a major category and includes land, buildings, and machinery. These assets are recorded at historical cost and are depreciated over their useful lives, with the exception of land. Depreciation allocates the cost of a tangible asset over its useful life, and accumulated depreciation is subtracted from the asset’s cost to find its net book value.

Intangible assets are non-physical resources with value, such as patents, copyrights, and goodwill. Goodwill is recorded when one company acquires another for a price greater than the fair market value of its identifiable assets. Long-term investments represent a company’s holdings in other entities that it intends to hold for more than a year.

A Breakdown of Liabilities

Similar to assets, liabilities are classified on the statement of financial position based on their due date. The two main categories are current liabilities and non-current liabilities.

Current Liabilities

Current liabilities are obligations expected to be settled within one year.

• Accounts payable is the amount a company owes to its suppliers for goods or services purchased on credit.
• Short-term debt includes loans and other borrowings that are due within one year.
• Accrued expenses are costs that have been incurred but not yet paid, such as salaries owed to employees.
• Unearned revenue represents payments received from customers for goods or services that have not yet been delivered.
• The current portion of long-term debt is the principal amount of a long-term loan due within the next year.

Non-Current Liabilities

Non-current liabilities, or long-term liabilities, are obligations that are not due within one year. Long-term loans, such as mortgages, are a primary example used to finance major purchases. Bonds payable are a form of long-term debt where a company issues bonds to investors to raise capital, obligating it to make interest payments and repay the principal at maturity.

Deferred tax liabilities arise from temporary differences between a company’s accounting income and its taxable income. Pension and other post-retirement benefit obligations represent a company’s commitment to provide retirement benefits to its employees.

A Breakdown of Equity

Equity represents the ownership interest in a company, also referred to as net assets or shareholders’ equity. The two main components of equity are paid-in capital and retained earnings.

Paid-in capital is the money that shareholders have invested in the company in exchange for stock. Retained earnings are the cumulative net income of the company that has been reinvested in the business rather than paid out to shareholders as dividends. This figure represents the profits a company has retained to finance growth or pay down debt. A consistent history of growing retained earnings can be a positive sign.

How to Analyze the Statement

The statement of financial position provides the data needed to perform fundamental analysis and gain insight into a company’s financial stability. By using the figures for assets, liabilities, and equity, one can calculate various financial ratios to evaluate different aspects of the business.

One of the most common ratios is the current ratio, calculated by dividing total current assets by total current liabilities. This ratio measures a company’s ability to meet its short-term obligations and is an indicator of liquidity. A higher current ratio suggests a greater ability to pay off short-term debts, while a low ratio could indicate potential liquidity problems.

Another metric is the debt-to-equity ratio, calculated by dividing total liabilities by total shareholders’ equity. This ratio measures the extent to which a company is using debt to finance its assets, a concept known as leverage. A high debt-to-equity ratio can indicate that a company has been aggressive in financing its growth with debt, which can result in higher risk. The appropriate level of debt can vary significantly by industry.