A balance sheet is a standardized financial statement that typically looks similar from company to company. Although the dollar amounts vary among different companies’ balance sheets, the general framework for the report stays the same enhancing comparability between companies, industries, and time periods.
The top section of a balance sheet reports all short-term assets. These items are listed based on liquidity. Therefore, it’s standard to list cash and cash equivalents first. In general, an asset is short-term if its benefits can and are expected to be used within the next year. For example, inventory is reported as a current asset because the company typically intends to sell the goods within the next 12 months. Other common examples of current assets include account receivables, note receivables, and prepaid assets.
The non-current assets section of a balance sheet focuses on the items of future benefit that will not be exhausted within one year. Although a small business still owns the right to use these assets, their expected life is greater than 12 months. For example, a small business may own a vehicle to use during operations. Although the vehicle will be used within the next 12 months, it is also likely that the useful life of the asset extends beyond this period. For this reason, it is grouped in a different category of assets a group considered to have long-term lives. In addition to a vehicle, other examples of non-current assets include buildings, land, equipment, and heavy machinery.
Other assets are items in which the useful life is unknown or extremely variable. Although a benefit exists, it is unclear when the benefit will be used. The most common examples of other assets are deferred tax benefits. They may be used next year or within the next few years. To preserve the conservation concept, it is separated out because it is unknown when it will be used.
Usefulness of Classifications
Although the classifications may seem arbitrary, they are useful for a number of external financial statement users. Financial institutions look at current assets to gauge a company’s ability to pay short-term obligations. They typically compare short-term assets to short-term liabilities to gauge a company’s liquidity. In addition, suppliers are interested in assets especially long-term assets. If a small business has a history of cash flow difficulties, the supplier may demand collateral in the form of non-current assets.
There are internal benefits of maintaining these separate categories, especially from the perspective of financial analysis. These different groups are used in ratio analysis to compare a company with its peers. For example, dividing current assets by current liabilities returns the current ratio, a metric that indicates your comparative debt levels. This information is useful to know from a long-term planning standpoint as well a day-to-day operations perspective. You should ensure the consistent use of asset classifications within your company to enhance internal and external reporting.