CHAPTER IV
THE BALANCE SHEET
Business Methods under the Microscope
The balance sheet is occupying an increasingly large place in all affairs of business and even of state, because the state is taking cognizance of business as never before. All phases of commercial activity are under the microscope. In these war times the government is tapping every available source of revenue. Kinds of property, property values, profits, rates of profit on capital invested—all are under investigation and the publicity resulting therefrom should make for a better conduct of future business. All this is forcing home to the manufacturer and trader some very obvious but long disregarded principles of business conduct necessary to secure health and long life. And these timely lessons will be of even greater use in the struggle for world markets that is imminent. As an interested party to any condition of business, labor also is claiming the right to be heard. The public in its direct dependence on certain classes of corporations for many of its necessities and most of its conveniences is also interested in the proper conduct of those businesses. As a factor in this increasing interest and scrutiny over business enterprises, exercised both from the inside and from external sources, banks are exerting a large and beneficent influence. The extension of credit, both bank and commercial, is no longer done by haphazard rule-of-the-thumb methods as in days gone by. Every applicant for credit must prove his right to it, must show cause why he deserves it, must present evidence of financial condition and standing on the basis of which the banker, the money lender, or the seller will be justified in extending all or some portion of the credit asked.
The Reading of the Balance Sheet
Because, in these and many other ways, the balance sheet offers the readiest means of securing the necessary information, it becomes an increasingly prominent statement. Before a proper understanding of the balance sheet can be had, and therefore before it can serve the various purposes to which it can be adapted, certain principles governing its make-up, both as to form and content, should be established. A proper reading of the balance sheet cannot be made without a thorough grasp of these principles.
The knowledge necessary for this is broadly of two kinds, viz.: (1) a knowledge of accounts, their technique, construction, and meaning; and (2) a knowledge of the principles of valuation as applied to business enterprises. The latter is not a domain of knowledge pre-empted by the accountant nor limited exclusively to his use. It touches more or less intimately all related fields of business endeavor. That is why the modern accountant needs a broad training and something more than a cursory knowledge of business practices and conditions. He should have a close acquaintance with the fundamental currents of business life, its organization and finance, and its basis in law, if he hopes to measure up to present-day requirements.
Thus not only is the accountant interested in the form and content of the balance sheet, but a proper understanding of it is valuable and increasingly necessary to all business men. In this chapter and those which follow, it is purposed to study these two problems of form and content, first establishing the broad basic principles and then showing in detail how these apply to various conditions and particular data. This chapter will concern itself with the problem of the make-up of the balance sheet so far as it relates to form.
Definition
George Lisle[4] defines a balance sheet as “a concise statement compiled from the books of a concern which have been kept by double entry, showing on the one side all the liabilities and on the other side all the assets of the concern at a particular moment of time.” Another writer says, “It is a cross-section of the business at a given instant”; and another, it is a “screen picture of the financial position of a going business at a certain moment.” As indicated by the first definition, an attempt is sometimes made to limit the term balance sheet to a statement made up from a double-entry set of books. With equal propriety it may be applied to any statement, whether made up from single- or double-entry books, or from any formal records, or from no records at all, which shows the assets and liabilities of a concern and the difference between them, i.e., the balance, as the item of net worth.
To distinguish this latter statement from the balance sheet when used in the restricted sense above referred to, the title, “statement of assets and liabilities” is sometimes used but there seems little reason for the distinction. Here the terms will be used as synonyms. The balance sheet then is a statement of financial condition as distinguished from a statement showing the operations of the business, and it is true only for a given moment of time. Theoretically the wheels of business are stopped momentarily, all operations cease, and a summary of the assets and liabilities then existing with their balance shown as net worth constitutes at that moment the balance sheet—the financial statement.