I mentioned a couple of weeks ago that I picked XBRL (eXtensible Business Reporting Language) as an essay topic. In order to get course credit for my internship, I have to write a 15-page “Issues and Solutions” essay about, well, and issue I encountered during my internship, and the solution to that issue.

I have completed most of the research I need to write the essay. Essentially, I’m addressing the issue of spending time re-formatting financial data to be able to analyze it for audit tests. My solution is XBRL, but honestly, the benefits XBRL will provide go far beyond solving the issue I saw. This post is intended to be an explanation of XBRL, and also an exercise for myself to make sure I feel confident about how to define the concept.

XBRL is a tagging system, that together makes up a language. Each little piece of data that goes into a financial statement is electronically “tagged” with a label that defines what type of data it is.

Think about how tags we already use online: tags on blog posts can help you instantly pull up all of the posts that mention an issue you’re interested in. Using a common hash tag on twitter (example #sxsw) can make it easy for interested people to find all of the tweets about a certain topic.

My first reaction to what I read about XBRL was confusion about why we haven’t been using this for years. The technology involved is not exactly cutting edge, and there are so many benefits that it seems silly not to be using it.

I think that the main roadblock was getting XBRL coordinated and accepted by enough people. Of course, Twitter tags are much more useful when everyone tweeting about a particular event or topic makes an effort to use one common tag. Similarly, everyone using XBRL has to use the same tags for the same data to make full use of XBRL’s capabilities.

That’s why an XBRL taxonomy has to be developed. It is like a dictionary of tags, and defines all the tags that should be used for each particular type of data. The now-released US GAAP taxonomy has over 13,000 tags in it! What a way to demonstrate the complexity of financial statements!

So, okay, I guess there are some reasons behind why XBRL took so long to make it this far. And how far is it? Well in December, the SEC passed a ruling requiring that public companies with a market cap of $5 billion or more must file XBRL financial reports for fiscal periods ending on or after June 15, 2009. These reports will not be audited, and will be issued in additional to traditional audited financial statements. Smaller public companies will have to begin filing with XBRL in the near future too.

My main conclusion though, after all my research, is that external reporting is just a small part of what XBRL can be used for. Rather than waiting for the SEC to require the switch, companies should be jumping to use XBRL as soon as possible, so that they can begin taking advantage of the internal uses of XBRL before their competitors do. Also, when they are required to begin using it, they will have more expertise than their peers, and may even find themselves in a position to consult with other companies about how to successfully manage the process!

Balance sheets are one of the main financial statements that investors use to assess a company. You can easily access a public company’s balance sheet through a website like Yahoo! Finance, but before you do you may want to arm yourself with this simple tutorial on how to read a balance sheet.

The three types of balance sheet accounts are assets, liabilities, and equity.

• Assets show what a company has. Under assets on the balance sheet, you will find items such as cash, inventory, and equipment.

• Liabilities show how much the firm in question owes to other people.

• Equity, in contrast to liabilities, is how much the firm owns.

Assets must always balance with liabilities and equity, hence the name balance sheet. The items that the firm has (assets) must either be owed or owned, so assets always equal liabilities plus equity. This relationship is called the Accounting Equation, and is the basis of double-entry accounting.

How to Make a Balance Sheet

Read on to see a simple example that will help you learn how to read a balance sheet by seeing how to create one.

Ernie has decided to start a small business raising dairy goats. He names the business E-Dairy and invests $10,000 into the business.

On the balance sheet: $10,000 is now E-Dairy’s asset. It can be used to buy things, and make money. The $10,000 is also recorded under equity because E-Dairy does not owe any of it to anyone.

Assets = $10,000
Liabilities = $0, Equity = $10,000

Next, Ernie decides to build a barn. A local construction company tells him it’ll cost $20,000. Since he doesn’t have much cash, Ernie gets a bank loan for $20,000, pays the builder, and gets his barn.

The barn is now listed as an asset worth $20,000. Because the money used to pay for it is a loan from the bank, Ernie must also list a $20,000 liability on the balance sheet.

Assets = $30,000
Liabilities = $20,000, Equity = $10,000

Finally, Ernie decides to buy his first goat for $3,000. The goat is an asset because Ernie will use it to make money. However, cash must decrease. In this case, all of the changes to the balance sheet will be among the assets, so liabilities and equity won’t change.

Assets = $30,000
Liabilities = $20,000, Equity = $10,000

Now you know the basics of how to read a balance sheet! Now you can try to read this balance sheet from Google’s financial statements. Don’t worry if a lot of it doesn’t make sense- now you know the basics of the three categories, and you can tell how much of Google’s assets are owed to other people, or owned by Google’s shareholders.

Photo of Cash: sxc.hu/isouthpawi
Photo of Barn: sxc.hu/drouu
Photo of Goat: sxc.hu/cegie