Balance Sheet Fundamentals: Structure, Liquidity, and Enforceability

Understanding the Balance Sheet Structure

The Balance Sheet is a fundamental accounting document that reflects the composition and value of a company's assets, liabilities, and equity at a given time. Its information acts like an economic snapshot of the company's financial position, making it static information related to a specific date. To understand and appreciate the change in equity during the reporting period, it must be compared with data from the previous period.

Legal Requirements for Comparison

The requirement for comparative data is often mandated by law:

Commercial Code Article 35.4: In each of the items in the balance sheet, the profit and loss account, and the financial statement, in addition to the figures for the year closing, those for the immediately preceding year should be included.

The Three Major Property Masses

The balance sheet structure follows highly accurate design criteria. Historically, the balance sheet included three large masses of property:

• Active (Assets): Assets and rights of the company, representing the application of funds raised by the Liabilities.
• Patrimonial Net (Equity) and Liabilities: Obligations, distinguishing between those which are required and those which are not, and within these, according to their maturity. Represents the source of funds.

Thereafter, the elements making up the balance sheet are ranked according to specific criteria:

Asset Classification: Availability and Liquidity

All asset components are sorted according to the criterion of availability or liquidity, which signifies the degree or ease with which an asset or a right can be converted into cash or liquid funds. Assets are typically listed from lowest to highest readiness (liquidity).

Examples of Asset Liquidity

• Debts not required of members or shareholders for the subscription of shares are unavailable as long as they are not yet required.
• Company machinery is hardly available because the company needs it for its production process.
• Store stocks have a higher degree of liquidity than fixed assets, as they are usually sold within one year.
• Customer debts are even more available because they are made effective in short periods, or they may be discounted in banks.
• The money in current accounts and cash represents the purest form of final liquidity.

Divisions of Assets

Assets are divided into two main parts:

1. Non-current Assets

   This section includes those assets whose expected stay with the company is estimated to exceed one year.

2. Current Assets

   This category includes those assets that are expected to be sold, consumed, or realized in the normal operating cycle, which generally does not exceed one year, and other assets whose maturity, sale, or execution is expected to be completed within a maximum of one year. Also included are financial assets classified as held for trading and cash and cash equivalents.

Equity and Liabilities: The Enforceability Criterion

Equity and Liability items are sorted according to the criterion of enforceability. A liability component is considered more required (enforceable) the shorter the deadline for fulfilling that obligation. They are included in the Balance Sheet sorted from lowest to highest degree of enforceability.

Divisions of Equity and Liabilities

Thus, the liabilities are divided into:

1. Net Equity (Patrimonio Neto)
2. Non-current Liabilities (Pasivo No Corriente)
3. Current Liabilities (Pasivo Corriente)

Source Citation: "Accounting and Taxation" U-11 Luis Rodero Díez 02/03/2009 Page 4