What is a balance sheet? A balance sheet is a financial snapshot at a given point in time. It’s what a small business owns and what it owes. It highlights SMB assets, the liabilities, plus the shareholder equity.
It is another leg of the small business financials stool.
What are Balance Sheets in Accounting?
A balance sheet highlights your financial position and, at the same time, your financial health. These financial statements include both long-term and current assets, cash and cash equivalents, accounts receivable, and the like.
The net assets are what’s left when you subtract liabilities. The liabilities and shareholders’ equity work as part of the balance sheet equation that goes like this: Assets = Liabilities+Equity
What is the Purpose of a Balance Sheet?
The balance sheet presents a clear picture of your financial situation. This is second in importance only to the income statement:
- Assessment of Liquidity: The balance sheet allows users to determine how well a company can meet its short-term financial obligations by comparing current assets to current liabilities. This tells stakeholders about the immediate financial strengths or vulnerabilities.
- Evaluation of Solvency: By looking at both short-term and long-term debts in comparison to assets, the balance sheet helps in understanding the long-term financial viability of a company. If the company has excessive debts in relation to assets, it might struggle in the future.
- Capital Structure Insight: The balance between equity and liabilities provides a glimpse into the company’s financing strategy. Firms that are heavily equity-financed might be less risky than those relying extensively on borrowed funds.
- Asset Management Analysis: Stakeholders can see how assets are distributed—whether in cash, accounts receivable, inventory, or fixed assets—and decide how effectively these assets are being managed or utilized.
- Historical Trend Comparison: Over time, comparing balance sheets from different periods can give insights into how a company is progressing. Increases in assets, reduction in liabilities, or growth in equity can be positive signs, while the opposite can raise concerns.
Main Components of a Balance Sheet
Breaking this financial statement down into parts makes it easier to understand. Here are the pieces that make balance sheets work.
1. Assets
These are also referred to as resources. When you own an asset, you expect there will be a future benefit. Hence things like accounts receivable get included. They generate cash flow, improve sales or reduce expenses and there are different categories.
- Current assets – Inventory and prepaid expenses. Things that will be cashed out within a year.
- Fixed Assets – Like equipment and buildings. Long-term resources.
There are also intangible assets like trademarks and financial assets like stocks and bonds.
2. Liabilities
A company’s liabilities are one of the key takeaways balance sheet supply. These keep a business moving forward. Long-term debt like interest payments is included and long-term liabilities cover items like mortgage payments.
3. Shareholder’s Equity
Some small businesses are publicly traded. They sell shares. This is what’s leftover after total liabilities have been paid.
Summary
| Component | Description |
|---|---|
| Assets (Resources with future benefits) | - Current Assets: Inventory and prepaid expenses (cashed out within a year). |
| - Fixed Assets: Equipment and buildings (long-term resources). | |
| - Intangible Assets: Trademarks, patents, etc. | |
| - Financial Assets: Stocks and bonds. | |
| Liabilities (Debts and obligations) | - Short-term Liabilities: Current debts, accounts payable, etc. |
| - Long-term Liabilities: Mortgages, long-term loans, etc. | |
| Shareholder's Equity (Residual interest after paying liabilities) | - Common shares, retained earnings, etc. |
- Read More: what is an income statement
The Balance Sheet Equation
The balance sheet equation is the foundation of double-entry bookkeeping and represents the core of the balance sheet: Assets = Liabilities + Equity.
This equation ensures that the balance sheet is always balanced, with each side reflecting the company’s financial position accurately.
Understanding this equation helps stakeholders grasp how transactions affect the overall financial health of the business. For instance, acquiring a new asset through a loan increases both the assets and liabilities side equally, maintaining the balance.
Balance Sheet Example
Reading about one of these statements is one thing. Seeing an example helps to clarify what’s in print. The one below is from the Harvard Business School online.
The above example will help you highlight any doubtful accounts so you can arrive at reasonable net worth.
Preferred stock can be added, and these shareholders have priority. In the end, using a template like this one will supply a good idea of owners’ equity. Plus a template gives you a good foundation to check YoY trends and other metrics.
How to Create a Balance Sheet
A balance sheet is one of the more important financial statements. Spreadsheets are a common format.
- Pick a Reporting Period – Balance sheets for public companies are usually quarterly. Fill these out to report on financial health annually too. A common date for a balance sheet here is December 31.
- List The Current Assets – Liquid assets go first such as cash, and company assets like inventory get added also. Don’t forget long-term assets, debt securities, and cash account goes here too.
- Make A List of The Liabilities – Add sections for current liabilities and noncurrent liabilities. This part of your statement of financial position needs a total.
- Calculate The Equity – The owner’s equity needs to go in here along with the shareholders’ portion too. The total goes on a sample balance sheet.
- Add Everything Up – Sort the numbers for liabilities, equity, and assets. Here’s the formula to complete this important financial statement. The sum of the liabilities and shareholder’s equity should equal total assets.
A monthly balance sheet gives an accurate picture of items like shareholder’s equity, current liabilities, and a company’s assets. It combines with other financial statements to list financial obligations in any period.
Read More: what is a cash flow statement
Analyzing a Balance Sheet
A company’s balance sheet provides numbers on assets, liabilities and how much financial risk you’re facing. It gives business owners a good overview of their operations and some ideas on what needs to be tweaked.
Here are some tips on reading the stats.
Read The Liabilities
This is an important part of the balance sheet. Don’t forget short-term items like accounts payable and long-term aspects like borrowing money on a bank loan.
If your SMB covers these, you need to add pension fund liabilities too, and payments made on other long-term investments. All the debt obligations should be considered.
Know The Assets
The company’s total assets get listed and the inventory the company owns is a current asset. How much cash and equivalents need to be analyzed too. Balancing assets and liabilities means looking at non-current assets too, like patents. Depreciation works on these items to affect net income in the end.
Shareholders Equity
These can be retained earnings at the end of a fiscal year. Everything needs to be organized by how current the numbers are.
Ratio Analysis
Financial strength ratios are the main technique and accounting equation used. These are actually a series of formulas arriving at the debt to equity ratio. And others.
Activity ratios are another common tool. It shows how a small business leverages its assets. Analysts often look at long-term assets and average total assets. Plus how a business manages its short-term receivables. Debt to equity securities is another ratio along with/or debt to assets and asset turnover.
Remember the owner’s equity gets placed at the end of the period.
The Importance of Balance Sheet for Investors and Creditors
For investors and creditors, the balance sheet serves as a vital tool for assessing a company’s financial health. It provides a snapshot of the company’s financial stability, liquidity, and overall risk profile at a specific point in time.
Investors look to the balance sheet to evaluate the company’s asset management efficiency and its potential for future growth. Specifically, they analyze the equity section to gauge the company’s capacity for generating returns on their investments.
Creditors, on the other hand, scrutinize the balance sheet to understand the company’s ability to meet its short-term obligations. They pay close attention to liquidity ratios and the levels of debt, as these metrics indicate the company’s short-term financial health and its ability to service its debts.
Therefore, the balance sheet is indispensable for making informed investment and lending decisions, highlighting the financial dynamics and potential vulnerabilities within a company.
The Role of Balance Sheet in Strategic Planning
The balance sheet plays a crucial role in a company’s strategic planning process. It provides business leaders with a comprehensive overview of the company’s financial standing, including its resources (assets) and obligations (liabilities and equity).
This information is instrumental in making strategic decisions such as investing in growth opportunities, paying down debt, or returning value to shareholders through dividends and buybacks.
The balance sheet’s insights into the company’s capital allocation help managers prioritize and direct financial resources toward the most promising areas for growth and efficiency improvements.
By understanding the composition and trends of assets, liabilities, and equity, businesses can better strategize for long-term success, ensuring that resources are optimally deployed to achieve financial stability and growth.
Balance Sheet vs. Income Statement and Cash Flow Statement
While the balance sheet offers a static view of a company’s financial position at a specific moment, the income statement and cash flow statement provide complementary perspectives that cover financial performance over a period.
The income statement details the company’s revenues, expenses, and profits, highlighting operational efficiency and profitability. The cash flow statement, meanwhile, focuses on the movement of cash into and out of the company, categorizing cash flows into operating, investing, and financing activities.
Together, these three financial statements provide a holistic view of a company’s financial health. Understanding how they interrelate is essential for comprehensive financial analysis, allowing stakeholders to assess a company’s profitability, cash management, and overall financial stability.
The Balance Sheet’s Critical Role in Business Success
The balance sheet is more than a financial statement; it’s a vital tool for assessing a company’s financial health, guiding strategic decisions, and providing transparency to stakeholders.
Understanding its components, how to interpret it, and its significance in the broader context of financial reporting and planning is essential for anyone involved in the business.
As we move forward, technological advancements promise to enhance the utility and accessibility of balance sheets, further solidifying their role in driving informed decision-making and business success.
- Read More: what is a profit and loss statement
What are the three main types of financial statements?
The information on the three types of financial statements is critical. It’s a snapshot of an SMB operating activities.
A Cash Flow Statement reports on cash flows, whats’ coming in, and what is going out. Cash flow statements have three sections, financing, investing, and operating.
Wondering what is an income statement?
The Income Statement highlights revenues and expenses. Additional paid-in capital expenses are found here. This statement is a driver of the other two types.
Finally, there’s The Balance Sheet. The book value perspective is found here, that’s basically what the company is worth.
If you’re wondering what is a profit and loss statement, those are records of expenses and revenue.
You can learn more from online experts like the Corporate Finance Institute.
Image: Depositphotos
