3.7 The Balance Sheet and Net Worth

The components of a balance sheet and what net worth means for a business or an individual.

Transcript (199 lines)

0:00 March thirty-first, closing time, the end of a rough first quarter.
0:05 Cami writes the day's cup count on the whiteboard by the sealing machine,
0:09 locks the door, and prints a single page dated today.
0:14 The income statement from last topic told a story with a beginning and an end:
0:18 a month of revenue coming in and costs going out.
0:22 This page holds still.
0:24 It lists everything Steep Street Boba owns, everything it owes,
0:28 and one number at the bottom that says what three years of work is worth to the
0:32 founder in the founding-day apron.
0:34 A loan officer will read this page in the spring.
0:37 This topic teaches you to read it first.
0:41 I'm Logan Shaffer, and this is MAMAKO's AP Business,
0:44 Topic 3.7: The Balance Sheet and Net Worth.
0:49 Two skills by the end: build a balance sheet from the accounting equation,
0:53 with assets ordered by liquidity and debts ordered by due date,
0:57 and read a finished sheet the way a lender does, for a business and for a household.
1:04 Practice questions for this topic are in the next video.
1:07 Let's go.
1:09 A balance sheet is a financial statement that compares a business's assets to its
1:14 liabilities and owners' equity at a specific point in time.
1:18 The comparison answers one question: after every debt is paid,
1:22 what is this business worth to its owners?
1:24 Notice the time frame.
1:26 Topic 3.6's income statement measured a period, a month or a quarter of activity.
1:31 A balance sheet measures an instant: one date printed at the top,
1:35 every number true on that date and free to change by the next morning.
1:39 The income statement is the movie; this page is the photograph.
1:43 One equation organizes the page: assets equal liabilities plus owners' equity.
1:49 The course calls it the balance sheet equation, or the fundamental accounting
1:54 equation.
1:55 Read it as a claim about who financed what.
1:58 Every item of value the shop holds was paid for by somebody,
2:01 either a lender who must be repaid or an owner who keeps whatever remains,
2:06 so what the business has always equals the claims against it.
2:11 The two sides match by definition, and that is why the page is called a balance
2:15 sheet.
2:18 Build the asset side first.
2:20 Assets are every item of value the business owns, and the sheet groups them
2:25 by liquidity: the ease with which an asset can be converted into cash.
2:30 Cash leads because it needs no converting; a commercial fridge sits far lower
2:34 because selling one takes weeks and a willing buyer.
2:38 The first group is current assets, the highly liquid items that fund day-to-day
2:42 operations.
2:44 Cash: nine thousand dollars in the shop's account at close on March thirty-first.
2:49 Inventory: two thousand dollars of tea, tapioca, syrup,
2:54 cups, and sealing film on the shelves.
2:56 Accounts receivable: fifteen hundred dollars, money owed to the business by
3:01 customers.
3:02 Here that means two winter catering invoices billed on thirty-day terms;
3:07 the events happened, the checks have not arrived.
3:10 The group also holds short-term investments, spare cash parked where it
3:14 earns interest and converts back quickly; Steep Street has none,
3:18 so no line appears. The second group is long-term assets, the less liquid items:
3:24 fixed assets and long-term investments.
3:26 Fixed assets are the physical property a business operates with.
3:30 A manufacturer lists its production plant here; Steep Street lists the sealing
3:36 machine, the tapioca cookers, the fridge, the ice machine,
3:39 and the rest of the gear.
3:41 That equipment cost nineteen thousand dollars in total,
3:44 the fifteen-thousand-dollar founding package plus four thousand of small wares
3:48 added since, and it appears at a book value of twelve thousand because equipment
3:53 loses value with use.
3:55 The third group is intangible assets: patents, brand names,
3:59 trademarks.
4:01 They have no physical form, and they carry value because they represent potential
4:06 revenue.
4:07 Steep Street's name pulls in customers on its own by now,
4:11 yet the sheet shows no intangible line, because Cami built her brand instead of
4:15 buying one; only a purchased brand arrives with a price to record.
4:20 Total the side: nine thousand plus two thousand plus fifteen hundred plus twelve
4:25 thousand is twenty-four thousand five hundred dollars of assets.
4:31 Now the claims.
4:32 Liabilities are the debts and obligations a business owes,
4:36 grouped by when payment is due.
4:38 Current liabilities are due within one year.
4:41 Accounts payable: fifteen hundred dollars, money owed to a business's suppliers,
4:47 here the tapioca and tea supplier who ships on thirty-day terms.
4:52 Receivable and payable are one arrangement seen from opposite sides:
4:56 an invoice the shop sent is a receivable, an invoice the shop received is a payable.
5:02 Next, the current portion of long-term debt.
5:05 The founding equipment loan still carries six thousand dollars,
5:09 and each three-hundred-dollar monthly payment retires two hundred fifty of
5:13 principal, so the coming year's twelve payments will clear three thousand
5:16 dollars, and that slice is listed as due now.
5:20 The current group also covers short-term debt and accrued operating expenses,
5:24 costs already incurred but not yet paid, like wages earned since the last payday;
5:30 this sheet happens to carry neither.
5:33 Long-term liabilities are obligations to pay beyond one year:
5:37 the loan's final three thousand dollars, scheduled for year five,
5:40 its last.
5:42 At larger scale this group holds mortgages, long-term bank loans,
5:45 and bonds.
5:47 Total the claims: fifteen hundred plus three thousand plus three thousand is
5:51 seventy-five hundred dollars of liabilities.
5:56 The equation now produces the bottom line.
5:59 Owners' equity, the net worth of the business, is the difference between assets
6:04 and liabilities: twenty-four thousand five hundred minus seventy-five hundred is
6:09 seventeen thousand dollars.
6:14 That seventeen thousand is the part of everything the shop holds that no lender
6:18 can claim, and it decomposes into two pieces.
6:22 Six thousand is Cami's original contribution, the bootstrap savings she
6:26 put in at founding.
6:28 Eleven thousand is retained earnings: the business's cumulative profits never paid
6:33 out, three years of net profit minus three years of owner draws,
6:37 left inside the shop as cash, inventory, and equipment.
6:42 A corporation's equity section runs the same logic with different words:
6:46 stock, the money shareholders paid in, plus retained earnings,
6:51 the cumulative profits not paid out as dividends.
6:54 When the exam gives you two of the equation's three totals,
6:58 solve for the third; when it gives all three, check the balance,
7:02 because a sheet that does not balance contains an error.
7:07 A balance sheet typically prints a second column beside the first:
7:11 the same snapshot from a previous year, or several, for comparison.
7:16 Steep Street's comparison column reads March thirty-first of last year.
7:20 Assets nineteen thousand four hundred: cash forty-three hundred,
7:24 inventory sixteen hundred, receivables six hundred, equipment then carried at twelve
7:29 thousand nine hundred.
7:31 Liabilities ten thousand four hundred, because six thousand dollars of loan still
7:35 sat beyond the one-year line.
7:37 Equity nine thousand.
7:39 Now read across the columns instead of down them.
7:42 Cash grew from forty-three hundred to nine thousand.
7:46 The loan balance fell by three thousand.
7:49 Equity climbed from nine thousand to seventeen thousand,
7:52 up eight thousand dollars, roughly the year's profit that stayed in the shop
7:56 after draws. One column reports condition; two columns report direction,
8:01 and this direction is a business getting stronger, with one soft quarter at the
8:06 end.
8:08 Who reads this page? Internal stakeholders first, meaning owners and managers:
8:13 Cami checks the cash line before committing to any new equipment,
8:16 because the sheet says what the shop can absorb.
8:19 External stakeholders next, meaning lenders and investors evaluating the
8:23 business's financial condition as of one date.
8:27 The spring refinancing application will put this exact page in a loan officer's
8:31 hands. The officer runs three checks.
8:34 One: is net worth positive?
8:37 Yes, assets exceed liabilities by seventeen thousand dollars.
8:42 Two: is there sufficient working capital, meaning do current assets meet or exceed
8:47 current liabilities, so day-to-day operations stay funded?
8:52 Current assets total twelve thousand five hundred against forty-five hundred of
8:56 current liabilities, so the shop could pay everything due this year almost three
9:00 times over.
9:02 Three: is the debt level comparable to similar businesses?
9:07 Six thousand of loan against twenty-four thousand five hundred of assets is modest
9:12 for a shop this size.
9:15 The same checks define what failure would look like.
9:18 A business that cannot access enough current assets to fund operations may shut
9:22 down, or pursue bankruptcy: a legal process through which a business
9:26 liquidates assets, eliminates or repays debts, and either closes or reorganizes
9:32 under legal supervision.
9:33 This sheet says Steep Street is nowhere near that line,
9:36 and saying so is the page's whole job.
9:40 The same equation runs on people, and this is the mirror card.
9:44 Personal net worth adds everything a household owns,
9:47 savings and investments, property, personal possessions,
9:51 and subtracts everything the household owes.
9:54 Sadie, festival week.
9:56 Assets: two hundred twenty dollars in savings, one hundred sixty in checking,
10:01 and about three hundred sixty dollars of belongings,
10:04 the phone, the bike, the camera.
10:07 Total, seven hundred forty.
10:10 Her one liability is sixty dollars, the remainder of a hundred-dollar advance from
10:14 her parents for a concert earlier this year, the debt her budget retires at
10:18 twenty dollars a month.
10:21 Seven hundred forty minus sixty is a net worth of six hundred eighty dollars.
10:27 Beside it, the shop: twenty-four thousand five hundred equals seventy-five hundred
10:32 plus seventeen thousand.
10:34 Same math, different zeros.
10:37 Net worth is typically calculated for a whole household,
10:40 which may include more than one person; Sadie's card is her own slice,
10:45 and a full household version adds every member's assets and debts,
10:48 the home and the mortgage included.
10:51 Lenders ask households for this page for the same reason the bank asks Cami:
10:56 a mortgage or auto-loan application wants assets and liabilities before anyone
11:00 signs.
11:02 And consumers and financial planners use the same number to answer the
11:06 longest-range money question there is: whether savings are sufficient to
11:10 retire on.
11:11 That version is already running inside this story.
11:14 Dorothy's net worth is how a sixty-five-year-old knows she can stay
11:18 retired, and her co-signature on Cami's loan is a claim against exactly that.
11:25 That's Topic 3.7.
11:27 The statement stack now holds two tabs: 3.6's movie of a month and today's
11:32 photograph of March thirty-first, balanced at twenty-four thousand five hundred.
11:37 One question stays open.
11:39 The photograph shows nine thousand dollars of cash and cannot explain why the pile
11:43 needs to be that tall.
11:45 July will sell forty-two hundred cups, February sold eighteen hundred,
11:49 and rent and payroll arrive on schedule through both,
11:52 so that cash line is doing a job no snapshot can show.
11:57 How money actually moves through the shop, month by month across a whole year,
12:01 is Topic 3.8, The Cash Flow Statement.
12:05 If this helped, a like tells YouTube to show it to more first-cohort students,
12:10 and subscribing gets you the whole course, in order,
12:12 as it's built.
12:14 And the free AP Business vocab pack, every key term from all five units,
12:19 is waiting at mamako.app, link below.
12:22 The 3.7 practice video is ready next.
12:25 See you next time.

A snapshot, and the equation that balances it

A balance sheet sets what a business owns against what it owes and what its owners are left with, all as of one specific moment. Notice how the time frame has changed. An income statement covered a stretch of activity, a month or a quarter of it. This page covers an instant instead: a single date sits at the top, and each figure below is accurate on that date and free to move by the following morning. If the income statement is the movie, this is the photograph.

A = L + E

One equation organizes the page, known as the balance sheet equation and also as the fundamental accounting equation. The way to read it is as a statement about financing. Anything of value in the business's hands was paid for by somebody, either a lender who has to be repaid or an owner who keeps whatever survives. What the business has therefore always equals the claims standing against it. Both sides agree by definition, which is the reason behind the name printed at the top.

Assets, in liquidity order

Assets cover every item of value in the business's hands, and the sheet arranges them by liquidity, which measures how readily something turns into cash. Cash itself heads the list, having nothing to convert, and a commercial refrigerator ranks far below it, because unloading one needs weeks and a buyer who wants it.

Current assets come first: the highly liquid items that fund day-to-day operations. The group covers cash, short-term investments, accounts receivable, and inventory. A receivable is money owed to the business by customers, so an invoice issued on thirty-day terms sits here until the check clears. A business holding no short-term investments simply shows no line, because a sheet lists what exists rather than every category that could exist.

Long-term assets come next, made of fixed assets and long-term investments. Fixed assets are the physical property the business operates with, from a manufacturer's production plant down to a small shop's equipment, and they appear at book value rather than at purchase price because equipment loses value with use. Nineteen thousand dollars of equipment bought over three years can appear at a $12,000 book value for exactly that reason.

The third group is intangible assets: patents, brand names, and trademarks. They have no physical form and carry value because they represent potential revenue. A brand a founder built herself can pull customers through the door and still show no line, because only a purchased intangible arrives with a price to record.

Liabilities, ordered by due date

Liabilities are the debts and obligations the business owes, grouped by when payment comes due. Current liabilities are due within one year and cover accounts payable, short-term debt, current payments on long-term debt, and accrued expenses, which are costs already incurred but not yet paid, such as wages earned since the last payday.

A receivable and a payable describe a single arrangement from opposite chairs. The invoice a business issued is its receivable; the invoice it received is its payable. The current portion of a long-term loan deserves particular attention, because one loan appears twice on the same page. If a $6,000 loan balance retires $250 of principal in each of the next twelve monthly payments, $3,000 of it is current and the remainder is long term.

Long-term liabilities are obligations to pay beyond one year, and at larger scale the group holds mortgages, long-term bank loans, and bonds. Sorting debt by due date is what lets a reader judge whether the coming year is survivable separately from whether the total borrowing is reasonable.

Owners' equity, and what it decomposes into

Owners' equity is the net worth of the business to its owners, and the equation produces it as the difference between assets and liabilities. Assets of $24,500 against liabilities of $7,500 leave $17,000 of equity, the part of everything the business holds that no lender can claim.

That figure decomposes into two pieces: what the owner put in, and what the business kept. A $6,000 founding contribution together with $11,000 of retained earnings, meaning profits accumulated and never distributed, produces that $17,000. At a corporation the same logic appears under different labels, stock alongside retained earnings. Given two of the three totals on an exam, solve for the missing one. Given all three, verify that the sides agree, since a sheet out of balance is a sheet containing a mistake.

A balance sheet also typically prints a second column beside the first, showing the same snapshot from a previous year for comparison. One column reports condition and two columns report direction. A prior-year column showing $19,400 of assets, $10,400 of liabilities, and $9,000 of equity turns this year's page into a story: the loan balance fell by $3,000 and equity climbed $8,000, roughly the year's profit that stayed inside the business after owner draws.

Reading the sheet like a lender

Internal stakeholders read this page first, meaning the owners and managers who check the cash line before committing to new equipment. External stakeholders read it next, meaning lenders and investors evaluating financial condition as of a single date. A loan application puts this exact page in a loan officer's hands, and the officer runs three checks.

Is net worth positive, meaning do assets exceed liabilities?
Is there sufficient working capital, meaning do current assets meet or exceed current liabilities so that day-to-day operations stay funded?
Is the debt level comparable to similar businesses?

Current assets of $12,500 against current liabilities of $4,500 mean the business could pay everything due this year almost three times over, and $6,000 of loan against $24,500 of assets is modest for a small operation. Those same three checks describe failure as well. A business that cannot reach enough current assets to keep operations funded may close its doors or file for bankruptcy, a legal proceeding in which assets are sold off, debts are cleared or rescheduled, and the business either shuts for good or reorganizes under a court's supervision.

The same equation, run on a household

Personal net worth adds everything a household owns, meaning savings and investments, property, and personal possessions, then subtracts everything it owes. A student with $220 in savings, $160 in checking, and about $360 of belongings holds $740 of assets, and a $60 remainder on a family advance is her only liability, so her net worth is $680. Beside a business at $24,500 equals $7,500 plus $17,000, it is the same equation with different zeros.

Net worth is typically calculated for an entire household, which may include more than one person, so a full version adds every member's assets and debts, a home and its mortgage included. A lender asks a household for this page for exactly the reason a bank asks a business. Before anyone signs a mortgage or a car loan, the application wants both sides of the equation on paper. Households and financial planners then put the identical figure to a further use, answering the money question with the longest horizon of all: is there enough set aside to stop working.

Essential knowledge covered on this page

Learning objective	Essential knowledge	Section
3.7.A Components of a business balance sheet	3.7.A.1, 3.7.A.2, 3.7.A.2.i, 3.7.A.2.ii, 3.7.A.2.iii, 3.7.A.2.iv, 3.7.A.3, 3.7.A.3.i, 3.7.A.3.ii, 3.7.A.4, 3.7.A.5	A snapshot and the equation, Assets in liquidity order, Liabilities ordered by due date, Owners equity
3.7.B Interpreting a balance sheet	3.7.B.1, 3.7.B.2, 3.7.B.3	Reading the sheet like a lender
3.7.C Purpose of determining personal net worth	3.7.C.1, 3.7.C.2, 3.7.C.3	The same equation, run on a household

CED essential knowledge for Topic 3.7

Worked Examples

Building a balance sheet and solving the equation

Assemble both sides of a balance sheet and solve for owners' equity.

At close on March 31 a shop holds $9,000 of cash, $2,000 of inventory, $1,500 of receivables, and equipment carried at a $12,000 book value. It owes $1,500 to suppliers, and $6,000 remains on an equipment loan of which $3,000 comes due inside the next year. Build the sheet.

Cash: $9,000
Inventory: $2,000
Accounts receivable: $1,500
Equipment at book value: $12,000
Accounts payable: $1,500
Loan balance outstanding: $6,000
Founder contribution at start: $6,000

1. Total the asset side
Add the four asset lines in liquidity order. $9,000 plus $2,000 plus $1,500 plus $12,000 is $24,500.
2. Split the loan by due date
Twelve monthly payments retire $250 of principal each, so $3,000 of the $6,000 is due within the year and $3,000 is not.
3. Total the liability side
Add the payable and both loan portions. $1,500 plus $3,000 plus $3,000 is $7,500.
4. Solve the equation for equity
Rearrange assets equals liabilities plus equity. $24,500 minus $7,500 is $17,000.
$E = A - L = 24500 - 7500$
5. Decompose the equity
Separate what the owner put in from what the business kept. A $6,000 founding contribution leaves $17,000 minus $6,000, or $11,000, as retained earnings.

Check answer

Answer
$17,000 of owners' equity. Assets of $24,500 against liabilities of $7,500 leave $17,000 of equity, made of a $6,000 contribution and $11,000 of retained earnings.

Why it matters
Splitting one loan across two liability groups is the step most often missed. It matters because a lender reads the current group to judge the coming year and the long-term group to judge the whole obligation.

Running the working capital check

Compute working capital and interpret it the way a lender does.

From the same sheet, current assets are cash of $9,000, inventory of $2,000, and receivables of $1,500. Current liabilities are $1,500 of payables and $3,000 of loan principal due this year. Run the check.

Cash: $9,000
Inventory: $2,000
Accounts receivable: $1,500
Accounts payable: $1,500
Current portion of debt: $3,000

1. Total current assets
Add the three liquid lines. $9,000 plus $2,000 plus $1,500 is $12,500.
2. Total current liabilities
Add what falls due inside the year. $1,500 plus $3,000 is $4,500.
3. Subtract to get working capital
$12,500 minus $4,500 leaves $8,000 of working capital.
$WC = 12500 - 4500$
4. Express the coverage as a ratio
Divide current assets by current liabilities. $12,500 over $4,500 is about 2.8, so this year's obligations are covered nearly three times over.

Check answer

Answer
$8,000 of working capital, covering current liabilities about 2.8 times. The business can meet everything due this year almost three times over out of assets it can convert quickly.

Why it matters
Working capital is the check that separates a solvent business from a merely profitable one. A business can report profit for the year and still fail this test, which is the case the cash flow statement exists to expose.

Running the same equation on a household

Compute personal net worth from a list of assets and liabilities.

In festival week a student holds $220 in savings, $160 in checking, and belongings, meaning a phone, a bike, and a camera, worth about $360. She still owes $60 on a $100 advance from her parents. Compute her net worth.

Savings: $220
Checking: $160
Belongings: about $360
Advance still owed: $60

1. Total everything owned
Add the savings, the checking balance, and the belongings. $220 plus $160 plus $360 is $740.
2. Total everything owed
Her only liability is the remaining $60 of the family advance.
3. Subtract to get net worth
$740 minus $60 leaves $680.
$NW = 740 - 60$
4. Set it beside the business version
The shop runs the identical equation at $24,500 equals $7,500 plus $17,000. Same structure, larger numbers.

Check answer

Answer
$680. Assets of $740 less liabilities of $60 give a personal net worth of $680.

Why it matters
Net worth is the number a lender asks a household for before a mortgage or a car loan, and the number a planner uses to judge whether savings will support a retirement. One equation, three very different decisions.

Practice Questions

6 questions. Nothing here is recorded or scored.

Question 13.7.A.2.ii
Broadleaf Landscaping
Ray Otero owns Broadleaf Landscaping, a four-person crew that mows lawns, plants beds, and builds patios for homeowners and two office parks. Ray wants a bank loan to buy a second truck, and the loan officer asks for a balance sheet dated the last day of the month. Ray lists what the business owns: the cash in the business account, a rack of fertilizer and mulch, 4,000 dollars of finished-job invoices the office parks have thirty days to pay, and the mowers, trailers, and truck the crew works from. Then he lists what the business owes: an unpaid bill from his mulch supplier and the balance on the loan that bought the first truck, which has three years of payments left. Where each item lands on the page will decide what the bank sees.
On the balance sheet, the 4,000 dollars of unpaid office-park invoices is best classified as which of the following?
- A.A current asset, because receivables are money customers owe.
- B.A current liability, because the office-park invoices are still unpaid.
- C.A long-term asset, because the office parks are repeat annual clients.
- D.Owners' equity, because Ray's crew has already earned the money.
Check answerHide answer
Answer: A
A.
Correct. A balance sheet lists assets in order of liquidity, the ease of converting each item into cash, and current assets are the highly liquid group that funds day-to-day operations: cash, short-term investments, inventory, and accounts receivable, money owed to a business by its customers. An invoice on a thirty-day clock converts to cash within weeks, so it sits near the top of the asset side.
B.
The bait is the word unpaid. Unpaid says a debt exists; it does not say which way the debt points. These invoices point toward Broadleaf, so they are a receivable and an asset; the mulch bill points away from Broadleaf, and that one is the liability.
C.
Repeat clients do not change an invoice's speed. Long-term assets are the items that serve the business for years, like the mowers and trucks; a bill on a thirty-day clock is about as short-term as an asset gets.
D.
This confuses earning with owning. Earned money lands on the sheet as an asset, and equity is only what remains after every liability comes off the top.
Question 23.7.A.3.i, 3.7.A.3.ii
Which of the following best describes how the remaining truck-loan balance appears on Broadleaf's balance sheet?
- A.Entirely as a current liability, because a truck payment comes due each month.
- B.Split into a current liability for this year and a long-term one for the rest.
- C.Entirely as a long-term liability, because the truck loan runs three more years.
- D.As a fixed asset, because the loan money paid for the crew's work truck.
Check answerHide answer
Answer: B
A.
This stretches the current piece across the whole balance. A monthly payment schedule does not make all three years of debt due within one year, and the one-year line is what the split respects.
B.
Correct. Liabilities group by when payment is due. Obligations due within one year are current liabilities, and the category includes the current payments on long-term debt, so the coming year's truck-loan payments list as current while the last two years of the loan list as long-term. One loan, two lines, sorted by the calendar.
C.
This stretches the long-term piece the same way. The coming year's payments are due within one year, and they belong on the current line however long the rest of the loan runs.
D.
This confuses the two sides of a single purchase. The truck is a fixed asset on the asset side, the loan that bought it is a debt on the other, and a financed purchase always writes on both sides of the sheet.
Question 33.7.A.1, 3.7.A.4
After Ray totals the two sides, which of the following best identifies owners' equity on the finished sheet?
- A.The cash balance sitting in the business account.
- B.Total assets added to total liabilities.
- C.Total assets minus total liabilities.
- D.The year's revenue minus the year's expenses.
Check answerHide answer
Answer: C
A.
This shrinks equity to a single asset. Cash is one line on the asset side, and equity is the claim left over across everything the business owns.
B.
This misremembers the equation. The plus sign sits between liabilities and equity, so solving for equity means subtracting.
C.
Correct. The balance sheet equation says assets equal liabilities plus owners' equity, so equity is what remains when liabilities come off assets: the net worth of the business to its owner. Equity typically builds from two sources, the owners' contributions plus retained earnings, the cumulative profits the business kept instead of paying out.
D.
The neighboring-statement borrow. Revenue minus expenses is net profit, an income-statement number covering a period, while equity is a balance-sheet number standing at one instant and accumulated over the business's whole life.
Question 43.7.C.1
Miriam, a dental hygienist, lists her household's finances for a mortgage application: 9,000 dollars in savings, 22,000 in retirement investments, a car worth 11,000, personal possessions worth 3,000, a 7,000-dollar car loan balance, and a 1,000-dollar credit card balance. Which of the following best identifies her household's net worth?
- A.53,000 dollars.
- B.23,000 dollars.
- C.45,000 dollars.
- D.37,000 dollars.
Check answerHide answer
Answer: D
A.
This adds the 8,000 of liabilities instead of subtracting them. No measure of net worth adds what the household owes to what it owns.
B.
This counts only the financial accounts minus the debts, but property and possessions are assets too: the car is worth 11,000 even with a loan riding on it, and the loan gets its own line on the other side.
C.
This adds the assets and stops, and no lender ignores the debts.
D.
Correct. Personal net worth runs on the business equation: add every asset the household owns, savings, investments, property, and personal possessions, then subtract every liability. Assets: 9,000 plus 22,000 plus 11,000 plus 3,000 is 45,000. Liabilities: the 7,000 car loan plus the 1,000 card balance is 8,000. 45,000 minus 8,000 is 37,000 dollars. Lenders may require a household's net worth as part of a loan application, and financial planners read the same number to judge whether savings can fund a retirement.
Question 53.7.B.2
Broadleaf Balance Sheet
Ray finishes the balance sheet, and the table shows it.
Line | Amount Cash | $7,000 Fertilizer and mulch inventory | $2,500 Accounts receivable | $4,000 Equipment at book value | $20,500 Total assets | $34,000 Accounts payable | $2,000 Truck-loan payments due within one year | $3,500 Truck-loan balance due beyond one year | $7,000 Total liabilities | $12,500 Owners' equity | $21,500 Which conclusion is supported by the balance sheet?
- A.Broadleaf cannot cover its current liabilities without selling its equipment.
- B.Broadleaf has positive net worth and enough working capital for operations.
- C.Broadleaf earned 21,500 dollars of profit over the past twelve months of work.
- D.Broadleaf carries more debt than comparable landscaping companies.
Check answerHide answer
Answer: B
A.
The working-capital arithmetic contradicts this outright: current assets of 13,500 stand against current liabilities of 5,500, so the current bills are covered without touching a mower.
B.
Correct. Run the checks a lender runs. Net worth: 34,000 of assets minus 12,500 of liabilities leaves 21,500 of equity, positive. Working capital: current assets are cash plus inventory plus receivables, 13,500; current liabilities are the payable plus the current loan payments, 5,500. Current assets exceed current liabilities by 8,000, so daily operations are funded.
C.
This reads equity as one year's profit, and equity is a lifetime number: Ray's contributions plus every year of retained profit since the crew started, none of it dated to this year.
D.
This fails the support rule. Judging whether debt is comparable to similar businesses requires numbers from those businesses, and this table has none. A conclusion the data cannot reach is wrong even when it might be true.
Question 63.7.B.3
A bakery's current liabilities are far larger than its current assets, and the owner cannot pay suppliers or staff. Which of the following best describes the bankruptcy process the owner is considering?
- A.A shutdown order that permanently closes the business that enters it.
- B.A private deal in which lenders erase the debts and collect nothing back.
- C.A court process for liquidating assets and settling or erasing debts.
- D.A government program that pays a struggling business's suppliers for it.
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Answer: C
A.
Reorganizing is half the definition, so a business can pass through bankruptcy and keep operating under supervision. Nothing about the process closes a business by default.
B.
This deletes the legal supervision and hardens debt relief into a gift. Bankruptcy can eliminate debts, repay them in part, or restructure them, and a court oversees which.
C.
Correct. Owners may shut down or pursue bankruptcy when a business cannot access sufficient current assets to fund operations, and bankruptcy is a legal process for liquidating assets, eliminating or repaying debts, and either closing the business or reorganizing it to continue under legal supervision.
D.
No government program pays a struggling business's suppliers for it. Bankruptcy is a court-supervised process the business itself enters, not aid that arrives from outside.

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6 common mistakes on 3.7

The wrong moves students actually make on these questions, why each one is wrong, and what to do instead. Part of the practice tier.

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3.7.A.1 · 3.7.A.2 · 3.7.A.2.i · 3.7.A.2.ii · 3.7.A.2.iii · 3.7.A.2.iv · 3.7.A.3 · 3.7.A.3.i · 3.7.A.3.ii · 3.7.A.4 · 3.7.A.5 · 3.7.B.1 · 3.7.B.2 · 3.7.B.3 · 3.7.C.1 · 3.7.C.2 · 3.7.C.3

3.7 The Balance Sheet and Net Worth

A snapshot, and the equation that balances it

Assets, in liquidity order

Liabilities, ordered by due date

Owners' equity, and what it decomposes into

Reading the sheet like a lender

The same equation, run on a household

Essential knowledge covered on this page

Worked Examples

Building a balance sheet and solving the equation

Running the working capital check

Running the same equation on a household

Key Terms

Practice Questions

6 common mistakes on 3.7

Essential knowledge covered