Balance sheets are important accounting tools for small businesses because they not only provide a snapshot of a business’s financial balances at a given point in time but can serve as key indicators of potential growth or decline. Below, we’ll delve into how to read and prepare a balance sheet and identify the components involved so you can maintain better accuracy when recording and calculating your business’s finances.
What Is a Balance Sheet?
A balance sheet is a financial statement used by businesses to keep track of finances and show their value within a specific period of time. It contains the assets and liabilities of a business, as well as equity. Assets are items of value owned by the business, and liabilities are the debts they owe. Equity belongs to the business owners and is equal to the amount left after assets and liabilities are considered. Balance sheets can be created on a monthly, quarterly, or yearly basis. These statements are important as they offer many insights to many stakeholders and considerations. An example might be a company’s financial position and ability to service its loans, which is useful for lenders when considering extending credit. A balance sheet can also provide information to investors about whether or not to invest in the business. It can be used in estate, legal, and tax matters.
What’s Included in a Balance Sheet?
To create a balance sheet, you’ll need to collect all receipts, invoices, and other financial documents to record your business’s finances. Using a chart, you’ll then record this data in one of the three sections: assets, liabilities, or equity.
Assets
Assets are items of value that the business owns. Some assets can increase the overall value of the business as these are items that can be sold or used to make products or deliver services that can be sold. Assets are classified as tangible and intangible assets. Tangible assets are physical objects that can also be categorized as fixed assets, meaning they are not for sale but rather used for operational purposes. Intangible assets, meanwhile, are not physical objects but concepts or ideas of value, such as intellectual property. Some examples of small business assets include: Tangible Assets
EquipmentPropertyPlant
Current Assets
Cash Inventory Accounts receivable
Intangible Assets
Goodwill Trademarks Copyrights Patents
On a balance sheet, assets are listed on the left side and are further divided into current assets and noncurrent assets. In the current assets section, you would include all the assets your business can expect to turn into cash within the current period. In the non-current assets, you would include all other assets that bring value to the business but aren’t expected to be sold or to bring in a cash value within the year.
Liabilities
Liabilities are essentially the debts of the business. This is what the business owes to other businesses, employees, and even customers. Liabilities are listed on the right side of the balance sheet, opposite of the assets. Some examples of liabilities include:
Accounts payable Taxes Bank loans Rent Utilities Payroll Goods owed to customers Bonds
Like assets, liabilities are divided into two categories: current liabilities and noncurrent liabilities. Current liabilities are the debts that are owed and must be paid within the year, such as accounts payable. Non-current liabilities are debts that are considered long-term and don’t need to be paid out fully within the year, such as loans.
Equity
Equity is considered the net worth of the business. On a balance sheet, it is listed after liabilities and represents the amount that would belong to the owners of the business if all assets were used to pay off all liabilities. It may also be referred to as shareholders’ equity or owner’s equity.
How To Prepare Your Balance Sheet
Once you understand what goes into a balance sheet, you can begin to create it. There are many templates and software programs available that provide the basic structure, making it easy for small business owners to get started. Here are a few basic steps to take to prepare your balance sheet:
Understanding Your Small Business Balance Sheet
After you fill in your balance sheet with all the necessary financial data, you can begin to analyze that data. Balance sheets offer many insights, including a company’s net worth, areas requiring more organization, progress made over time, and the ability to show your business is worthy to lenders. You can use your balance sheet to calculate key ratios, which can help you to understand your business’s financial standing. Here are some examples:
Debt Ratio: The debt ratio is used to determine the financial standing by determining debt using the formula: Debt Ratio = Total Liabilities ÷ Total Assets Working Capital: Working capital refers to the funds used to cover operating costs and can be calculated using this formula: Working Capital = Current Assets - Current Liabilities Debt-to-Equity Ratio: The debt-to-equity ratio shows a business’s leverage regarding its capital and whether the majority of it is debt or shareholders’ equity. It is calculated with the formula: Debt/Equity Ratio = Total Liabilities ÷ Total Equity
