Understanding Balance Sheets

Balance Sheets

• Balance sheets represent a snapshot of assets and liabilities.
• Both corporations and individuals can utilize balance sheets.
• Assets are items of value owned.
• Liabilities are debts or obligations owed.
• Equity signifies net worth, calculated by subtracting liabilities from assets.
• Assets = Liabilities + Equity is a fundamental accounting equation.
• Balance sheets are typically structured in two columns, with assets on the left and liabilities plus equity on the right.

Bank Balance Sheet Example

• Initial assets consist of $1,000,000 in building and equipment.
• There are $0 in initial liabilities, with no borrowing assumed.
• Initial equity amounts to $1,000,000, derived from assets minus liabilities.
• A customer makes a cash deposit of $1,000,000.
• Reserves subsequently increase by $1,000,000.
• A demand deposit liability of $1,000,000 is established.
• Demand deposits refer to funds that depositors can withdraw at any time.

Fractional Reserve System

• Banks do not need to hold all demand deposits as reserves.
• The required reserve ratio determines the percentage of demand deposits banks must maintain in reserve.
• Excess reserves can be loaned out; 90% in the described scenario.
• With a 10% required reserve ratio, a $1,000,000 demand deposit necessitates $100,000 in required reserves, leaving $900,000 in excess reserves
• Loans are considered assets for the bank, representing future borrower payments.
• Banks generate revenue through interest charged on loans.

Balance Sheet Impact of Loans

• The bank extends $900,000 in loans, utilizing excess reserves.
• These loans become an asset worth $900,000.
• Total assets now amount to $2,000,000, encompassing building, reserves, and loans.
• Total liabilities plus equity also equal $2,000,000, comprising demand deposits and equity.
• Assets remain equivalent to liabilities plus equity.