Liabilities represent a company's obligations to creditors while net worth represents the owner's investment in the company. In reality, both creditors and owners are investors in the company; the only difference is the degree of nervousness and the time frame in which they expect repayment.

Assets

As noted previously, anything of value that is owned or due to the business is included under the assets section of the balance sheet. Assets are shown at net book or net realizable value (more on this later), but appreciated values are not generally considered.

Current Assets

Current assets are those which mature in less than one year. They are the sum of the following categories:

• Cash
• Accounts Receivable (A/R)
• Inventory (Inv)
• Notes Receivable (N/R)
• Prepaid Expenses
• Other Current Assets

Cash

Cash is the only game in town. Cash pays bills and obligations; inventory, receivables, land, building, machinery, and equipment do not, even though they can be sold for cash and then used to pay bills. If cash is inadequate or improperly managed, the company may become insolvent and be forced into bankruptcy. Include all checking, money market, and short term savings accounts under cash.

Accounts Receivable (A/R)

Accounts receivable are dollars due from customers. They arise as a result of the process of selling inventory or services on terms that allow delivery prior to the collection of cash. Inventory is sold and shipped, an invoice is sent to the customer, and later cash is collected. The receivable exists for the time period between the selling of the inventory and the receipt of cash Receivables are proportional to sales; as sales rise, the investment you must make in receivables also rises.

Inventory

Inventory consists of the goods and materials a company purchases to re-sell at a profit. In the process, sales and receivables are generated. The company purchases raw material inventory that is processed (aka work in process inventory) to be sold as finished goods inventory. For a company that sells a product, inventory is often the first use of cash. Purchasing inventory to be sold at a profit is the first step in the profit-making cycle (operating cycle), as illustrated previously. Selling inventory does not bring cash back into the company - it creates a receivable. Only after a time lag equal to the receivable's collection period will cash return to the company; thus it is very important that the level of inventory be well-managed so that the business does not keep too much cash tied up in inventory, as this will reduce profits. At the same time, a company must keep sufficient inventory on hand to prevent stockouts (having nothing to sell) because this too will erode profits and may result in the loss of customers.

Notes Receivable (N/R)

N/R is a receivable due the company in the form of a promissory note, arising because the company made a loan. Making loans is the business of banks, not operating businesses, particularly small companies with limited financial resources. Notes receivable is probably a note due from one of three sources:

• Customers
• Employee 
• Officers of the company

Customer notes receivable is when the customer who borrowed from the company probably borrowed because they could not meet the accounts receivable terms. If the customer fails to pay the invoice according to the agreed-upon payment terms, the customer's obligation may be converted to a promissory note. Employee notes receivable may be for legitimate reasons, such as a down payment on a home, but the company is neither a charity nor a bank. If the company wants to help the employee, it can co-sign on the loan advanced by a bank.

An officer or owner borrowing from the company is the worst form of notes receivable. If an officer takes money from the company, it should be declared as a dividend or withdrawal and reflected as a reduction in net worth. Treating it in any other way leads to possible manipulation of the company's stated net worth, and banks and other lending institutions frown greatly upon it.

Other Current Assets

Other current assets consist of prepaid expenses and other miscellaneous current assets.

Fixed Assets

Fixed assets represent the use of cash to purchase physical assets whose life exceeds one year. They include assets such as:

• Land
• Buildings
• Machinery and Equipment
• Furniture and Fixtures
• Leasehold Improvements

Intangibles

Intangibles represent the use of cash to purchase assets with an undetermined life; they may never mature into cash. For most analysis purposes, intangibles are ignored as assets and are deducted from net worth because their value is difficult to determine. Intangibles consist of assets such as:

• Research and Development
• Patents
• Market Research
• Goodwill
• Organizational Expense

In several respects, intangibles are similar to prepaid expenses - the use of cash to purchase a benefit which will be expensed at a future date. Intangibles, like fixed assets, are recouped through incremental annual charges (amortization) against income. Standard accounting procedures require most intangibles to be expensed as purchased and never capitalized (put on the balance sheet). An exception to this is purchased patents that may be amortized over the life of the patent.

Other Assets

Other assets consist of miscellaneous accounts such as deposits and long-term notes receivable from third parties; they are turned into cash when the asset is sold or the note is repaid. Total assets represent the sum of all assets owned by or due to the business.

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