What is a Balance Sheet?

What is a balance sheet?

A balance sheet is sometimes also referred to as a statement of financial position or a statement of net worth during a particular period of time, usually the last accounting cycle or financial year. A balance can be thought of as being somewhat similar to a bank statement as it provides details on how much a company or business is worth and how much it owes.

A balance sheet will show information on a business’s total amount of assets and if those assets were financed by debt or equity. The balance sheet will also contain details on all of a business’s liabilities. In the case of a balance sheet for an incorporated limited company, the balance sheet will also show details on the company shareholders’ equity and how much the shareholders have each invested into the enterprise. 

A balance sheet is usually organised into two different sections. On the left side, all assets will be listed. The right side of the balance sheet provides information on shareholders’ equity and any liabilities the business may have. Assets and liabilities are divided into two categories: current assets and current liabilities, and fixed assets and fixed liabilities. The current assets listed will typically include a business’s inventory, cash that it holds, short-term investments and so on. The fixed assets section will detail equipment, machinery, long-term investments and the like. 

Why a balance sheet is important for your business

Every business owner should periodically have a balance sheet created for them or they should write one themselves. The information contained in a balance sheet can provide an insight into the viability and profitability of a business. This makes it easier to track expenditures and earnings.

It can also provide up-to-date information on the financial standing of a business that can be used to attract investors or secure a bank loan. By analysing the balance statement, investors and lenders can see how a business has performed in the past, how it is performing at the present moment and how it is expected to perform in the future. Without a balance sheet, it is extremely unlikely that a business will be able to provide enough financial details to satisfy lenders or potential investors. 

The balance sheet equation explained

Balance sheets are compiled by using a fundamental equation: Assets = Liabilities + Shareholders’ Equity. The formula shows that a company must pay for the assets it owns by either accruing debt (liabilities) or acquiring them via funding from investors (shareholder equity). Assets, liabilities and shareholders’ equity are therefore the three main components of a balance sheet. 

Assets

When creating a balance sheet, bookkeepers define anything that creates economic value and generates revenue for a business. In simple terms, if a thing can be turned into cash, then it is an asset. This definition includes fixed assets such as:

• Equipment
• Tools
• Machinery
• Furniture
• Real estate
• Long-term investments

As well as current assets, such as:

• Cash
• Cash equivalents
• Marketable securities
• Inventory
• Short-term investments
• Accounts receivable

Liabilities

Liabilities, on the other hand, are anything that requires expenditure in the future, such as debt or money owed. Current liabilities include:

• Accounts payable
• Notes payable with a 12-month period 
• Long-term debt that has come due

Fixed liabilities include:

• Notes payable over the long-term
• Any deferred tax liabilities
• Long-term debt 

Shareholders’ equity

Shareholders’ equity is defined as all funds that the owners have invested into the business. This amount includes share capital, which is derived from shareholders and retained earnings, which are profits that are not paid out to shareholders as dividends but are used to grow the business instead.

How to write a balance sheet

Accountants and bookkeepers use different approaches to writing a balance sheet and every is business unique, so it can be difficult to generalise too much when considering how to write a balance sheet. However, there are typically five steps that are taken when creating a balance sheet.  

Step one: Decide the time period the balance sheet covers

When determining the time period of a balance sheet, two steps should be taken. Firstly, the actual time period that the balance sheet will report on must be decided, for example, the fiscal year or the first quarter of the year. Then, a reporting date must be decided. If, for example, the reporting period is the first quarter, then the balance sheet will look at business data from January 1^st to March 31^st. The reporting date in this instance would be the first of April.

Step two: Compile a list of assets as of the reporting date

Organise all assets owned by the company as of the reporting date. These assets should then be categorised as current or fixed assets and assigned a value. All categories should be added up to arrive at subtotals which are then added to provide the overall total value of the assets.

Step three: List all liabilities as of the reporting date

Just as you compiled a list of all the business’s current and fixed assets, all current and fixed liabilities must be detailed as individual line items on the balance sheet. The liabilities must be then added up to provide subtotals for each liability category and an overall total amount. 

Step four: Determine shareholders’ equity

Details of the total amounts of share capital that has been invested in the business must be calculated. This figure should also include retained earnings used for reinvestment purposes. When compiling this section, a bookkeeper may need to take into account common stock, preferred stock and treasury stock.

Step five: Apply the balance sheet equation

Compare the total amount of assets against all liabilities and total amounts of shareholder equity. This will provide a clear insight into the financial standing of the company as of the reporting date for the reporting period. These figures can then be used to extrapolate expected future earnings and show the past growth of the business.

How to analyse a balance sheet

Using the data contained in the balance sheet can provide a business owner with a clear picture of their enterprise’s liquidity, its leverage and its rates of return. If the total sum of the current assets is greater than the total sum of the liabilities, then the business can be said to be in good financial shape and is able to cover the costs of its short-term obligations. 

To fully analyse the information in the balance sheet, it is helpful to compare the most recent balance sheet with the previous one. If there is a decrease in a company’s cash reserves, for example, this may indicate that the business is in financial trouble. 

There are three main points to look for when analysing a balance sheet:

• The leverage ratio: The leverage ratio is used to determine how much of a business’s overall capital is acquired via debt. An example of this is the debt-to-equity ratio which divides the shareholders’ equity by the amount of liabilities to provide an insight into the worth of a business as compared to its amount of debt
• The return on equity: This metric provides details on the percentage of returns gained from equity investments. To calculate the return on equity, divide the net income of the business by the total amount of shareholders’ equity
• The return on assets: This is used to show the profitability of a business and its value in relation to the amount of assets it holds. This figure is arrived at by dividing the net income of the business by its assets

Does a small business need a balance sheet?

A balance sheet can provide essential information on the past performance of a business and its expected future performance. This holds true regardless of the size of the enterprise. A small business owner can use the details contained in a balance sheet in much the same way that the CEO of a large company can, for example, as proof that the business can afford to take out a loan. Comparing balance sheets provides insights into how a business is performing and can help stakeholders make informed decisions about strategies to promote further growth. 

If you are unsure of your skills when it comes to accounting, it is advisable to enlist the help of a professional bookkeeper or accountant. A specialised business accountant can help you to write a balance sheet, keep journal entries and create a chart of accounts. They can also advise you on the best form of accounting for your business. Many business owners choose to also use accounting software to assist them in keeping precise records. 

You can also enhance and streamline your accounting processes with the payment card from Mooncard. Mooncard’s payment card system tracks all expenditures made by employees on behalf of your business. Whenever a purchase is made, a digital photo of the receipt is taken, and an expense report is automatically created. This report is then forwarded to the relevant accounting team.

Mooncard makes it easy to stay on top of your business expenses and provides you with an easy to access record of all expenditures. To arrange a free, no-obligation online demonstration of the Mooncard corporate card, simply visit the Mooncard website today! 

More articles on accounting : 

• Financial statement analysis