A balance sheet is a type of financial statement that includes a company’s assets and liabilities, as well as the shareholders’ equity during a certain period of time. The purpose of a balance sheet is to calculate a company’s capital structure, showing what the company owes in debt and owns in assets.
In commercial real estate, the balance sheet would show the debt owed in mortgage payments, the amount other investors have put in, and the overall value of a property. This information gives an idea of the state of the property owner’s finances at a given time. To analyze the balance sheet, it’s good to see how certain trends are playing out over a long period of time, comparing current balance sheets to past ones.
Understanding a Balance Sheet
A balance sheet uses a specific formula to calculate total assets:
Liabilities + Shareholders’ Equity = Assets
The money borrowed is the liability, and the shareholders’ equity is the stake investors have in the property. Therefore, the total amount becomes the assets. A person or company has to pay for everything they own (assets) by borrowing money (liabilities) or taking money from investors (shareholders’ equity).
For example, if you were to take out a $1 million loan to purchase a retail property, your assets and liabilities would increase by $1 million, balancing both sides of the equation. If someone were to invest $50K into your property, then the assets and shareholders’ equity would each increase by $50K. Any extra revenue generated that is not used for expenses would then go to the investor’s equity account.
Breaking Down the Balance Sheet
In the assets section of a balance sheet, accounts are listed in order of their liquidity, with separate sections for current assets, which could be converted into cash quickly, and non-current, or long-term assets, which cannot be quickly converted to cash.
Some of these types of current assets, in order of liquidity, include:
- Cash and cash equivalents, such as treasury bills or certificates of deposit
- Marketable securities, which are equity and debt securities that can be liquidated
- Accounts receivable, which is money that customers owe the company
- Inventory, which includes goods available for sale
- Prepaid expenses, which is anything that has already been paid for, like insurance and rent
Some long-term assets include:
- Long-term investments, which cannot be liquidated within a year’s time
- Fixed assets, which encompass land, machinery, buildings, etc
- Intangible assets, which are non-physical, such as intellectual property. These are only included on a balance sheet if they are acquired.
Liabilities are everything a company owes, such as mortgage payments, interest, wages, rent, utilities, taxes and more. Liability insurance can help mitigate some of these risks.
Shareholders’ equity is anything attributed to investors and shareholders. This amount equals the total assets of the company minus the liabilities, and it is sometimes called “net assets.”
Importance of a Balance Sheet
In commercial real estate, a balance sheet is essential for financial planning. However, it is only one of several types of financial statements real estate investors and property owners should rely on to run a successful business.