6.1 Balance Sheet

The balance sheet lists the dollar value of what the company owns (assets), what it owes to creditors (liabilities) and the amount contributed by investors (equity). Assets always equal liabilities and equity.

Assets = Liabilities + Equity

Assets are divided into two categories, current and fixed. Current assets are those that can be quickly converted, generally in less than a year. These include inventory, accounts receivable and cash. Fixed assets are those that cannot be easily converted. In the simulation, fixed assets are limited to the value of the plant and equipment (see “4.3.1 Capacity” and “4.3.3 Automation”).

Liabilities include accounts payable, current debt and long term debt. In the simulation, current debt is comprised of one-year bank notes; long term debt is comprised of 10-year bond issues. Equity is divided into common stock and retained earnings.

Retained earnings are a portion of shareholders’ equity. They are not an asset.

Common stock represents the money received from the sale of shares; retained earnings is the portion of profits that was not distributed back to shareholders as dividends, but was instead reinvested in the company.

Depreciation is an accounting principle that allows companies to reduce the value of their fixed assets. Each year some of the value is “used up.” Depreciation decreases the firm’s tax liability by reducing net profits while providing a more accurate picture of the company’s plant and equipment value. Depreciation is expensed, product by product, on the income statement. Total depreciation for the period is reflected as a gain on the cash flow statement. On the balance sheet, accumulated depreciation is subtracted from the value of the plant and equipment. The simulation uses a straight line depreciation method calculated over fifteen years.

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