What is a Balance Sheet?
The balance sheet together with income and cash flow statements make up the company’s financial statements and paint a clear picture of how well it is performing. A balance sheet gives a snapshot of your finances at a particular moment, incorporating every journal entry since your company launched. It shows what your business owns (assets) on the one side, and what it owes (liabilities) and what money is left over for the owners (owner’s equity) on the other side.
For the balance sheet to reflect the true picture, both sides should be equal: Assets = Liabilities + Equity.
Because it summarises a business’s finances, the balance sheet is also sometimes called the statement of financial position. Companies usually prepare one at the end of a reporting period, such as a month, quarter, or year.
The balance sheet is one of the three main financial statements, along with the income statement and cash flow statement.
The Purpose of a Balance Sheet
The balance sheet reveals your business’s overall financial health by reflecting every transaction since your company started. At a glance, you’ll know exactly how much money you’ve put in, or how much debt you’ve accumulated. Plus, you can compare current assets to current liabilities to make sure you’re able to meet upcoming payments.
The information in your balance sheet can help you calculate key financial ratios, such as:
- The “debt to equity” ratio, which shows the ability of a business to pay for its debts with equity.
- The current ratio: Current assets / Current liabilities. This will tell you whether you have the ability to pay all your debts in the next 12 months.
You can also compare your latest balance sheet to previous ones to examine how your finances have changed over time. You’ll be able to see just how far you’ve come since day one.
What’s Makes a Balance Sheet?
There are three main data points that are required: assets (current and long-term), liabilities, and equity.
Assets
These are the things your business owns that have a monetary value. List your assets in order of liquidity, or how easily they can be turned into cash, sold or consumed. Anything you expect to convert into cash within a year is called current assets.
Current Assets
Current assets can easily be converted into cash and they include cash and any cash equivalents such as inventory and receivable accounts. Of course, cash is the most important current asset, but it also includes:
- Money in a checking account
- Money in transit (money being transferred from another account)
- Accounts receivable (money owed to you by customers)
- Short-term investments
- Inventory
- Prepaid expenses
- Cash equivalents (currency, stocks, and bonds)
Cash equivalents include any asset which can readily be liquidated into cash, such as equipment, vehicles, machinery and inventory which belongs to the company. When a company sells a product or service to a consumer on credit, these are also considered as current assets.
Long-term assets, on the other hand, are things you don’t plan to convert to cash within a year.
Long-Term Assets
Long-term or non-current assets are any investments made by the company in the long term. They are non-current assets because their value will not be ascertained during the current financial year. Long-term assets can refer to:
- Buildings and land
- Machinery and equipment (less accumulated depreciation)
- Intangible assets like patents, trademarks, and goodwill (you would list the market value of what fair price a buyer might purchase these for)
- Long-term investments
Whilst these are not physical assets, they are valuable resources that can have a huge impact on a company. Coca-Cola’s trademark logo, for instance, is an intangible asset and its value cannot be understated.
Next, comes your liabilities — what your business owes to others.
Liabilities
Liabilities are any financial obligations the company owes to third parties. Just like assets, liabilities can be both short (current) and long-term.
Your current liabilities might include:
- Accounts payable (what you owe suppliers for items you bought on credit)
- Wages you owe to employees for hours they’ve already worked
- Loans that you have to pay back within a year
- Taxes owed
Your (non-current) long-term liabilities include:
- Loans that you don’t have to pay back within a year
- Bonds your company has issued
And thirdly, you have to include your equity.
Equity
Equity is money currently held by your company. This category is usually called “owner’s equity” for sole proprietorships and “stockholders’ equity” for corporations. It shows what belongs to the business owners.
Owners’ equity includes:
- Capital (money invested into the business by the owners)
- Private or public stock
- Retained earnings (all your revenue minus all your expenses since launch)
Equity can drop when an owner draws money out of the company to pay themselves, or when a corporation issues dividends to shareholders.
You may also have some shareholder equity, which is the amount of cash that has been invested into a business. At the end of the financial year, if the company decides to reinvest its earnings (after taxes) back into it, these earnings will be transferred to the balance sheet into a shareholder’s equity account.
This account is representative of the company’s overall net worth. For the balance sheet to balance properly, total assets on the one side must be at least equal to the total liabilities in addition to shareholders’ equity on the other side.
The Balance Sheet Equation
This primary formula for the accounting equation is the key to the balance sheet:
A company must pay for everything that it owns (its assets) by either taking money from investors (issuing shareholders’ equity) or borrowing money from banks (liabilities). As a result, the total assets must equal total liabilities plus the company’s equity in-order to stay out of the red.
Assets go on one side, liabilities plus equity go on the other. The two sides must balance — hence the name “balance sheet.”
What Should The Finished Balance Sheet Look Like?
You can create your balance sheet as you see fit, but here’s what a sample balance sheet looks like, in a proper format:
What Do I Do With the Balance Sheet?
Because the balance sheet reflects every transaction since your company started, it reveals your business’ overall financial health. At a glance, you’ll know exactly how much money you’ve put in, or how much debt you’ve accumulated. Or you might compare current assets to current liabilities to make sure you’re able to meet upcoming payments.
You can also compare your latest balance sheet to previous ones to examine how your finances have changed over time. You’ll be able to see just how far you’ve come since day one.
If you’re tired of manually creating these sheets over, and over again, consider a much easier method of managing your finances…
Using a finance management platform
Try using a finance management tool such as Friday Finance. Friday Finance is a unified financial management solution that marries your bank statements to generate your cash flow statements automatically. That way you don’t have to go through the messy process of waiting for your accounting statements, or transferring and categorising all your transactions yourself.
It is important to note that a finance management platform does not necessarily need to cover the bookkeeping and accounting too. Most finance processes eventually yield into the accounting landscape however.
A finance management tool like Friday Finance generates direct cash flow statements instead of using accounting data long after the expenses happen for an indirect cash flow statement. The Friday Finance home screen shows all the data needed for financial reports.
Friday Finance allows you to connect your bank accounts, which auto-categorises all your historic transactions. In addition, you can also initiate new payments and have them categorised for your cash flow statements from the get-go as well. Friday Finance then produces your direct cash flow statement for you in real-time and even lets you input your cash flow forecast numbers in the spreadsheet based on your planned billings.
