# Balance Sheet

## Balance Sheet (West's Encyclopedia of American Law)

A comprehensive financial statement that is a summarized assessment of a company's accounts specifying its assets and liabilities. A report, usually prepared by independent auditors or accountants, which includes a full and complete statement of all receipts and disbursements of a particular business. A review that shows a general balance or summation of all accounts without showing the particular items that make up the several accounts.

(The entire section is 66 words.)

## Balance Sheets (Encyclopedia of Management)

The balance sheet, also known as the statement of financial position, is a snapshot of a company's financial condition at a single point in time. It presents a summary listing of a company's assets, liabilities, and owners' equity. The balance sheet is prepared as of the last day of the business year. Therefore, it corresponds to the end of the time period covered by the income statement.

To understand the balance sheet, its purpose, and its contents, several accounting concepts need to be examined. First of all, the balance sheet represents the accounting equation for a company. The accounting equation is a mathematical expression that states the following:
Assets = Liabilities + Owners' Equity

Stated more fully, this means that the dollar total of the assets equals the dollar total of the liabilities plus the dollar total of the owners' equity. The balance sheet presents a company's resources (i.e., assets, or anything the company owns that has monetary value) and the origin or source of these resources (i.e., through borrowing or through the contributions of the owners). By expressing the same dollar amount twice (once as the dollar total of the assets, then as the dollar total of where the assets came from or who has an equity interest in them), we see that the two amounts must be equal or balance at any given point in time.

An interesting observation about the balance sheet is the valuation at which assets are presented. The average person would assume that the assets listed on the balance sheet would be shown at their current market values. In actuality, generally accepted accounting principles require that most assets be recorded and disclosed at their historical cost, or the original amount that the company paid to obtain ownership or control of the assets. As time passes, however, the current value of certain assets will drift further and further away from their historical cost. In an attempt to present useful information, financial statements show some assets (for which there is a definite market value) at their current market value. When there is no specific market value, historical values are used. An expanded discussion of this concept will follow.

A simple example of a balance sheet appears in Table 1.

ASSETS

As a category, assets include current assets, fixed or long-term assets, property, intangible assets, and other assets.

CURRENT ASSETS.

Assets can be viewed as company-owned or controlled resources, from which the organization expects to gain a future benefit. Examples of assets for a typical company include cash, receivables from customers, inventory to be sold, land, and buildings. In order to make the balance sheet more readable, assets are grouped together based on similar characteristics and presented in totals, rather than as a long list of minor component parts.

The first grouping of assets is current assets. Current assets consist of cash, as well as other assets that will probably be converted to cash or used up within one year. The one-year horizon is the crucial issue in classifying assets as current. The concern is to

 Assets Liabilities and Owners' Equity Current assets 600,000 Current liabilities 280,000 Fixed Assets 90,000 Long-term debt 500,000 Property 800,000 Owners' equity 900,000 Intangible assets 50,000 Other assets 140,000 TOTAL ASSETS 1,680,000 TOTAL LIABILITIES AND OWNERS' EQUITY 1,680,000

present assets that will provide liquidity in the near future. Current assets should be listed on the balance sheet in the order of most liquid to least liquid. Therefore, the list of current assets begins with cash. Cash includes monies available in checking accounts and any cash on-hand at the business that can be used immediately as needed. Any cash funds or temporary investments that have restrictions on their withdrawals, or that have been set up to be spent beyond one year, should not be included in current assets.

Temporary investments known as trading securities are short-term investments that a company intends to trade actively for profit. These types of investmentsommon to the financial statements of insurance companies and banksre shown on the balance sheet at their current market value as of the date of the balance sheet. Any increase or decrease in market value since the previous balance sheet is included in the calculation of net income on the income statement.

The next category on the list of current assets is accounts receivable, which includes funds that are to be collected within one year from the balance sheet date. Accounts receivable represent the historical amounts owed to the company by customers as a result of regular business operations. Many companies are unable to collect all of the receivables due from customers. In order to disclose the amount of the total receivables estimated to be collectible, companies deduct what is known as a contra account. A contra account has the opposite balance of the account from which it is subtracted. The specific account title might be "allowance for uncollectible accounts" or "allowance for bad debts," and its balance represents the portion of the total receivables that will probably not be collected. The expense related to this is shown on the income statement as bad debt expense. The net amount of accounts receivable shown is referred to as the book value. Other receivables commonly included on the balance sheet are notes receivable (due within one year) and interest receivable.

Inventory is shown next in the current asset section of the balance sheet. If the company is a retailer or wholesaler, this asset represents goods that a company has purchased for resale to its customers. If the company is a manufacturer, it will have as many as three different inventory accounts depending on the extent to which the goods have been completed. Inventory classified as raw materials represents the basic components that enter into the manufacture of the finished product. For a tractor manufacturer, raw materials would include the engine, frame, tires, and other major parts that are directly traceable to the finished product. The second type of inventory for a manufacturer would be goods in process. As the name implies, this category represents products that have been started but are not fully completed. After the goods are completed, they are included in the final inventory classification known as finished goods. The value assigned to inventory is either its current market price or its cost to the manufacturer, whichever is lower. This is a conservative attempt to show inventory at its original cost, or at its lower market value if it has declined in value since it was purchased or manufactured.

The final group in the current assets section of the balance sheet is prepaid expenses. This group includes prepayments for such items as office supplies, postage, and insurance for the upcoming year. The total for these items is shown at historical cost.

FIXED OR LONG-TERM ASSETS.

These assets differ from those listed under current assets because they are not intended for sale during the year following the balance sheet date; that is, they will be held for more than one year into the future. Such asset investments are classified under the headings of held to maturity for investments in debt instruments such as corporate or government bonds, and available for sale for investments in equity (stock) instruments of other companies or debt securities that will not be held to maturity. Held-to-maturity investments are disclosed in the balance sheet at their carrying value. The carrying value is initially equal to the historical cost of the investment; this amount is adjusted each accounting period so that, when the investment matures, its carrying value will then be equal to its maturity value. These adjustments are included in the calculation of income for each accounting period. Available-for-sale investments are adjusted to market value at the end of each accounting period, and these adjustments are included in the calculation of owners' equity.

PROPERTY.

Sometimes listed under the expanded heading property, plant, and equipment, this section of the balance sheet includes long-term, tangible assets that are used in the operation of the business. These assets have a long-term life and include such things as land, buildings, factory and office equipment, and computers. Land is listed first because it has an unlimited life, and it is shown at its historical cost. The other assets, such as buildings and equipment, are shown at book value. Book value is the original cost of the asset reduced by its total depreciation since being placed into service by a company. This net amount is frequently called net book value, and it represents the remaining cost of the asset to be depreciated over the remaining useful life of the asset.

Several methods are used to calculate depreciation (e.g., straight-line and accelerated), and each uses a mathematical formula to determine the portion of the original cost of the asset that is associated with the current year's operations. Note that depreciation is not an attempt to reduce a long-lived asset to its market value. Accountants use market value on the balance sheet when it is readily available and required for use by generally accepted accounting principles. However, in the case of many property items an unbiased estimate of market value may not be available. As a result, accountants use the asset's historical cost, reduced by the depreciation taken to date, as an indication of its remaining useful service potential.

INTANGIBLE ASSETS.

Some long-lived assets of a company represent legal rights or intellectual property protections that are intangible by nature. Examples of this type of asset include a company's patents, copyrights, and trademarks. Each of these assets has a legally specified life and expires at the end of that period, although a few can be renewed. Accountants attempt to measure this decline in usefulness by amortizing the historical costs of these assets. This concept is the same as recording depreciation for items of tangible property discussed above.

One special type of intangible asset is known as goodwill. Goodwill is acquired when one company purchases another company and pays more than the estimated market value of the net assets held by the purchased company. The buying company might do this for a number of reasons, but it is often necessary in order to encourage the previous owners to sell, and to guarantee that the acquisition is successful. The difference between the purchase price and the market value of the assets also can be attributed to intangible factors in the purchased company's success, such as proprietary processes or customer relationships. Like other intangible assets, the historical cost of goodwill is amortized over its future years. Accounting rules set a maximum life of 40 years for goodwill, but this rule will be reduced to 20 years in the future.

OTHER ASSETS.

This final section covering the disclosure of assets on the balance sheet is a miscellaneous category that includes any long-lived asset that does not fit in any of the categories defined above. This category might include such assets as long-lived receivables (from customers or related companies) and long-lived prepaid insurance premiums (those paid for coverage beyond the next year from the balance sheet date). Another example is a deferred charge (such as a deferred tax asset), or an amount that has been prepaid based on generally accepted accounting principles and holds future benefit for the company.

LIABILITIES

Liabilities include current liabilities, as well as long-term debt.

CURRENT LIABILITIES.

Current liabilities are debts that come due within one year following the balance sheet date. These debts usually require cash payments to another entity, and they often have the word "payable" as part of their name. Accounts payable are amounts owed to suppliers by a company that has purchased inventory or supplies on a credit basis. Interest payable represents interest that has accrued on notes payable or other interest-bearing payables since the last payment was made by a company; this type of payable might be included in a general group known as accrued expenses. Other current liabilities include estimated warranty payments, taxes payable, and the current year's portion of long-term debt that is coming due within one year from the balance sheet date.

LONG-TERM DEBT.

Long-term debts are those that come due more than one year following the balance sheet date. They include bonds payable, mortgage payable, and long-term notes payable, all of which have a specific maturity date. Deferred income taxes payable might also be disclosed in this category. The latter item is rather technical and controversial; it arises when accounting rules used in preparing the financial statements for reporting to owners differ from rules used on income tax returns for income tax authorities. Deferred income taxes payable typically result from an item being deducted on the income tax return (as allowed by tax rules) before it is reported as an expense on the income statement (as allowed by generally accepted accounting principles). When these timing differences reverse in future years, the deferred income taxes payable category is removed as the actual payment to tax authorities is made.

OWNERS' EQUITY

This final section of the balance sheet is one of the most difficult to comprehend. It is known as stockholders' equity for a corporation and consists of several possible subdivisions: paid-in capital, adjustments for changes in value of certain investments in stocks of other companies, and retained earnings. The paid-in capital section discloses the investment made in the corporation by the stockholder-owners. It will include the amount paid into the corporation by the stockholders for different types of equity instruments that have been issued by the corporation, such as preferred stock equity and common stock equity. Paid-in capital usually is separated into two partshe par value of the stock and the amount paid in excess of the par values required by generally accepted accounting principles.

Adjustments for market value changes in available-for-sale investments in other companies are shown as a component of owners' equity. These adjustments also are reported in comprehensive income, because they reflect a change in owners' equity that is not a part of net income. Changes in the value of trading securities, which are short-term investments, are included in the calculation of net income, whereas changes in value of available-for-sale securities are reported only in owners' equity and the statement of comprehensive income.

The last category usually found under the heading of owners' equity is retained earnings. This amount represents any earnings (or the difference between total net income and net loss) since the inception of the business that have not been paid out to stockholders as dividends.

Returning to the aforementioned accounting equation, a user of financial statements can better understand that owners' equity is the balancing amount. If assets are considered a company's resources, they must equal the "sources" from which they came. The sources for assets are a company's creditors (as seen in the total of the liabilities) and its owners (as seen in the total for owners' equity). As such, retained earnings does not represent a fund of cash; instead it represents the portion of each asset that is owned by the stockholders. The remaining portion of each asset is owed to creditors in the form of liabilities.

It is important to keep in mind that the balance sheet does not present a company's market value. While some assets are presented at market value, others cannot be disclosed at market value because no such specific market value exists. The changes in the value of the assets that are required to be adjusted to market value for each balance sheet are included in either net income or comprehensive income, depending on the nature of the asset and the purpose for which management chose to acquire it.

Another important consideration about the balance sheet is the manner in which both assets and liabilities are separated into current and noncurrent groups. While not all companies will have all of the classifications discussed above, all will have both current and noncurrent items. This separation allows the user of the balance sheet to compare a company's current liquidity needs and resources to its long-term solvency status.

In conclusion, balance sheets are an important tool to help managers, lenders, and investors analyze a company's financial status and capabilities. They are particularly useful in helping to identify trends in the areas of payables and receivables. However, it is vital to remember that the document only presents a company's financial situation at a given point in time. It does not provide any information about the past decisions that helped the company to arrive at that point, or about the company's future direction or potential for success. For this reason, the balance sheet should be considered along with other required financial statements, as well as historical data, when evaluating a company's performance.

"Balance Sheets." Business Owner's Toolkit. 2005. CCH Tax and Accounting. Available from <<a href="http://www.toolkit.cch.com/text/P06_7035.asp">http://www.toolkit.cch.com/text/P06_7035.asp>.

Byrnes, Nanette. "The Downside of Disclosure: Too Much Data Can Be a Bad Thing. It's Quality of Information That Counts, Not Quantity." Business Week, 26 August 2002, 100.

Davenport, Todd. "The Uneven Evolution of Accounting Standards." American Banker, 28 July 2004.

## Balance Sheet (Encyclopedia of Small Business)

A balance sheet is a financial report that provides a summary of a business's position at a given point in time, including its assets (economic resources), its liabilities (financial debts or obligations), and its total or net worth. "A balance sheet does not aim to depict ongoing company activities," wrote Joseph Peter Simini in Balance Sheet Basics for Nonfinancial Managers. "It is not a movie but a freeze-frame. Its purpose is to depict the dollar value of various components of a business at a moment in time." Balance sheets are also sometimes referred to as statements of financial position or statements of financial condition.

Balance sheets are typically presented in two different forms. In the report form, asset accounts are listed first, with the liability and owners' equity accounts listed in sequential order directly below the assets. In the account form, the balance sheet is organized in a horizontal manner, with the asset accounts listed on the left side and the liabilities and owners' equity accounts listed on the right side. The term "balance sheet" originates from this latter form, for when the left and right sides have been completed, they should have equal dollar amountsn other words, they must balance.

CONTENTS OF THE BALANCE SHEET

Most of the contents of a business's balance sheet are classified under one of three categories: assets, liabilities, and owner equity. Some balance sheets, though, also include a "notes" section wherein relevant information that does not fit under any of the above accounting categories is included. Information that might be included in the notes section would include mentions of pending lawsuits that might impact future liabilities or changes in the business's accounting practices.

ASSETS Assets are items owned by the business, whether fully paid for or not. These items can range from cashhe most liquid of all assetso inventories, equipment, patents, and deposits held by other businesses. Assets are further categorized into the following classifications: current assets, fixed assets, and miscellaneous or other assets. As David H. Bangs Jr. related in Finance: Mastering Your Small Business, "the list of assets starts with cash and ends with the least liquid fixed assets, those that are the hardest to turn into cash. For instance, if you have an item labeled 'good will' on your balance sheet, you'll have to sell the business itself to turn that particular asset into cash."

Current assets include cash, government securities, marketable securities, notes receivable, accounts receivable, inventories, prepaid expenses, and any other item that could be converted to cash in the normal course of business within one year. Fixed assets, meanwhile, include real estate, physical plant, leasehold improvements, equipment (from office equipment to heavy operating machinery), vehicles, fixtures, and other assets that can reasonably be assumed to have a life expectancy of several years. It is recognized, however, that most fixed assetslthough not landill lose value over time. This is known as depreciation. When determining a company's fixed assets, then, a business owner needs to make certain that depreciation is figured into the final value of his or her fixed assets. The net fixed asset value of a company's holdings is calculated as the net of cost minus accumulated depreciation. Finally, businesses often have assets that are less tangible than securities, inventory, or high-speed printers. These are classified as "other assets" and include such intangible assets as patents, trademarks, and copyrights, notes receivable from officers or employees, and contracts that call for them to serve as exclusive providers of goods or services to a client. Writing in Finance for Non-Financial Managers and Small Business Owners, Lawrence W. Tuller defined intangible assets as "any expenditure that adds value to the company but cannot be touched or held."

LIABILITIES Liabilities, on the other hand, are the business's obligations to other entities as a result of past transactions or events. These entities range from employees (who have provided work in exchange for salary) to investors (who have provided loans in exchange for the value of that loan plus interest) to other companies (who have supplied goods or services in exchange for agreed-upon compensation). Liabilities are typically divided into two categories: short-term or current liabilities and long-term liabilities.

Liabilities that qualify for inclusion under the short-term or current designation include all those that are due and payable within one year. These include obligations in the areas of accounts payable, taxes payable, notes payable, accrued expenses (such as wages, salaries, withholding taxes, and FICA taxes) and other expenses that are supposed to be paid off over the next year. Such obligations include the portion of long-term debt that is scheduled to be paid off during the course of the coming year. Long-term liabilities are those debts to lenders, mortgage holders, and other creditors that will take more than one year to pay off.

OWNERS' EQUITY Once a business has determined its assets and liabilities, it can then determine owners' equity, the book value of the business's assets once all liabilities have been deducted. Owners' equity, which is also sometimes called stockholders' equity, is in essence the net worth of the company.

A comprehensive, accurate balance sheet can be a valuable tool for the small business owner or entrepreneur seeking to gain a full understanding of his or her operation. Studying current assets and current liabilities, for instance, can reveal significant information about a company's short-term strength. "If current liabilities exceed current assets, the business may have difficulty meeting its payment obligations within the year," wrote Simini. "In fact, some experts feel that in a well-run company current assets should be approximately double current liabilities." Indeed, balance sheetsf produced on a monthly or quarterly basis and compared with earlier statementsan provide entrepreneurs and small business owners with valuable information on operating trends and areas of developing strength or weakness. "By analyzing a succession of balance sheets and income statements, managers and owners can spot both problems and opportunities," noted Simini. "Could the company make more profitable use of its assets? Does inventory turnover indicate the most efficient possible use of inventory in sales? How does the company's administrative expense compare to that of its competition? For the experienced and well-informed reader, then, the balance sheet can be an immensely useful aid in an analysis of the company's overall financial picture."

Given the balance sheet's value in providing an overview of a company's financial standing at a given point in time, it is understandably one of the primary financial documents demanded by prospective lenders, investors, and business clients. Small business owners, then, need to recognize that the investment of time necessary in compiling balance sheets (which is minimal in most instances because of the proliferation of business software available on the market) is decidedly worthwhile.

Atrill, Peter. Accounting and Finance for Nonspecialists. Prentice Hall, 1997.

Bangs, David H., Jr., with Robert Gruber. Finance: Mastering Your Small Business. Upstart, 1996.

Simini, Joseph Peter. Balance Sheet Basics for Nonfinancial Managers. Wiley, 1990.

## Balance Sheet (Encyclopedia of Business)

In accounting, a balance sheet is a type of financial statement that provides a synopsis of a business entity's financial position at a specific time, including a company's economic resources (assets), economic obligations (liabilities), and the value of a company after its liabilities are subtracted from its assets (owners' equity). The term "balance sheet" refers to the way assets always equal (or balance) liabilities plus owners' equity. Also known as a statement of financial position or a statement of financial condition, the balance sheet usually presents financial information in one of the following formats:

• Assets = Liabilities + Owners' equity
• Assets - Liabilities = Owners' equity

Balance sheets come in two forms: report form and account form, which contain the same information but present it differently. In the report form, the balance sheet lists asset accounts first, and lists the liability and stockholders' equity accounts in sequential order directly below the assets (see Figure 2). In the account form, the balance sheet is organized in a horizontal manner, with the asset accounts listed on the left side and the liabilities and owners' or stockholders' equity accounts listed on the right side (see Figure 1).

The heading of the balance sheet contains the name of the business, the name of the statement (i.e., "Balance Sheet") and the date of the statement as of the close of business on that date.

CONTENT OF THE STATEMENT

The balance sheet discloses major classes and amounts of a company's assets as well as major classes and amounts of its financial structure, including liabilities and equity. Major classifications used in the statement include:

1. Assetsnything owned by a company that has monetary value, including economic resources that have current and probable future value:
• Current assets (cash, marketable securities, accounts receivable or debt owed to a company, inventory, and prepaid expenses)
• Investments
• Fixed assets (property, plant, and equipment)
• Intangible assets (patents, copyrights, goodwill)
• Deferred charges or other assets
2. Liabilitiesurrent and probable future debts owed by a company against its assets, including the obligations of a business to transfer assets or provide services to other parties in the future as a result of past transactions or events:
• Current liabilities (accounts payable, notes payable, wages payable, and taxes payable)
• Long-term liabilities (bonds payable, pensions, and lease obligations)
• Other liabilities
3. Owners' equityhe resources invested in a company by the owner. Owners' equity is equal to the assets after deducting the liabilities:
• Capital stock
• Other paid-in capital in excess of par or stated value
• Retained earnings (dividends)

The essential characteristics of an asset include: (1) it is owned, not leased, by a company, and (2) it has present or future value and a capacity to contribute directly or indirectly to future net cash inflows, either by itself or in combination with other assets.

The essential characteristics of a liability include: (1) it embodies a present duty or responsibility to one or more parties to repay a debt, and (2) the duty or responsibility obligates a particular company, leaving it little or no discretion to avoid paying the debt. Since companies find it convenient and often necessary to purchase materials and supplies on credit, all companies have liabilities. When companies purchase goods on credit, they incur the liability known as an account payable. On the other hand, when companies borrow money, they incur the liability known as a note payable.

Current assets are cash and other assets that are expected to be converted into cash, sold, or consumed either in the year or in the operating cycle of the business, whichever is longer. Current liabilities are the obligations that are reasonably expected to be liquidated either through the use of current assets or the creation of other current liabilities.

Assets are classified in the balance sheet from most liquid to least liquid. Liabilities are classified in the order of maturity. Owners' equity items are classified according to source and in their decreasing order of permanence.

Balance sheets are usually presented in comparative form. Comparative financial statements include the current year's statement and statements of one or more of the preceding accounting periods. For example, companies often provide five- or ten-year balance sheets, which make them useful for evaluating and analyzing trends and relationships.

Notes added to the balance sheet provide additional information not included in the accounts on the financial statements as well as explanations of figures presented in the balance sheet. Moreover, additional information can be disclosed by means of supporting schedules or parenthetical notation.

RECOGNITION AND MEASUREMENT

For an item to be recognized in a balance sheet, the item and information about it must: (1) meet the definition of an element of accounting (the broad classes of items comprising the balance sheet), (2) be measurable (valuation), (3) be relevant, and (4) be reliable.

Assets and liabilities are measured or reported on the balance sheet by different attributes (for example, historical cost, current replacement cost, current market value, net realizable value, and present value of future cash flows), depending upon the nature of the item and the relevance and reliability of the attribute measured. The valuation method primarily used in balance sheets currently is historical cost because it is measurable and provides information that has a relatively high degree of reliability. Historical cost is the price paid for an asset when it was acquired. While this method does not factor in inflation, it provides a convenient, objective way of determining an asset's value because any accountant can verify the cost paid for an asset and because companies generally acquire fixed assets such as property and buildings for business use, not for selling.

Other valuation methods include the current cost, current market value, net realizable value, and present value approaches. Current cost is the amount of cash or cash equivalent required to obtain the same asset at the balance sheet date. Current market value or exit value is the amount of cash that may be obtained at the balance sheet date by selling the asset in an orderly liquidation. Net realizable value is the amount of cash that can be obtained as a result of future sale of an asset. Present value is the expected exit value discounted to the balance sheet date.

CONSOLIDATED BALANCE SHEET

Consolidated financial statements represent the combined financial position of both parent and subsidiary companies. A consolidated balance sheet is presumed to present more meaningful information than separate financial statements of the affiliated companies and must be used in substantially all cases in which a parent company directly or indirectly controls the majority voting stock (over 50 percent) of a subsidiary. Consolidated financial statements should not be prepared in those cases in which the parent's control of the subsidiary is temporary or where there is significant doubt concerning the parent's ability to control the subsidiary. Furthermore, the consolidated balance sheet does not include revenues and expenses resulting from intercompany transactions, i.e., transactions between parent and subsidiary companies.

USES AND LIMITATIONS

The balance sheet assists external users of financial statements in assessing a company's liquidity, financial flexibility, and operating capabilities, as well as in evaluating the earnings performance for the period. Liquidity describes the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid. Financial flexibility is the ability of an enterprise to take effective action to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities. Operating and performance capabilities refer to the capability and effectiveness of a company related to its major or ongoing revenue producing activities.

Many bankers and miscellaneous users of balance sheets consider having total current assets that are roughly twice as much as its total current liabilities a sign of a company's creditworthiness. Consequently, they use balance sheets to determine the ratio of a company's total current assets to its total current liabilities, or the current ratio. Creditors compute the current ratio by dividing the total current assets by the total current liabilities, yielding a measurement of a company's ability to repay debt. The amount of current assets over current liabilities is a company's working capital. Banks also rely on balance sheets to determine a company's liquidityhe amount of cash and assets easily convertible to cash, such as a company's accounts receivable.

The balance sheet has major limitations, however. The balance sheet does not necessarily reflect the fair market value of assets because accountants typically apply the historical cost principle in valuing and reporting assets and liabilities. The balance sheet omits many items that have financial significance. Furthermore, professional judgment and estimates are often used in the preparation of balance sheets, possibly impairing the usefulness of the statements. Finally, since balance sheets contain only financial information, they do not list such important information as the intensity of a company's competition and the experience and skill of a company's management personnel, which affect a company's financial performance.