When you own a business, it’s important to be an accurate bookkeeper. You might be required to maintain books and prepare a balance sheet for your company for tax, legal and/or regulatory purposes. In addition, you might want to voluntary prepare a balance sheet to help you monitor the assets, liabilities and net worth of your company. Knowing how to prepare or read and understand a balance sheet is a critical skill for all small business owners. A balance sheet is part of your company’s financial statements which also include the income statement, the statement of shareholder’s equity and the cash flow statement. Financial statements are linked. For example, the balance sheet is connected to the cash flow statement as the cash balance that appears on the balance sheet is the ending balance used in the cash flow statement.
Financial statements help you and others (e.g., investors, lenders) to assess your company’s financial health.
Discover what a balance sheet can be used for and how it can help you identify financial strengths and weaknesses that exist in your company.
What is a balance sheet used for?
A balance sheet is a financial statement that reports a company’s assets, liabilities and shareholders’ equity.
Balance sheets are prepared as of a specific point in time (e.g., month-end, quarter-end, year-end).
Note: Not a period of time as the balance sheet is prepared at a point in time. A balance sheet is a financial statement that reports a company’s assets, liabilities and shareholders’ equity.
A balance sheet includes the following elements:
- Assets: This is anything your company owns with value. Assets can be current or noncurrent. This includes cash and cash equivalents, prepaid expenses, accounts receivable, real estate, inventory, investments, intangible assets and other assets with value.
- Liabilities: This includes anything your company owes. Liabilities can be either current or noncurrent. Some examples include interest payable on loans, accounts payable (e.g., rent, utilities), long-term debt (e.g., loans) and deferred tax liability.
- Shareholders’ equity: This refers to anything that belongs to the shareholders of your company after accounting for any liabilities, Also known as net assets, shareholders’ equity is the difference between a company’s total assets and its liabilities. In small businesses or sole proprietorships, net assets are referred to as owner’s equity.
Four ways to use a balance sheet
Preparing a balance sheet can help in any number of situations. Here are four ways you can use a balance sheet for your business.
1. Assess your company’s financial standing and health
A balance sheet gives you a snapshot of your company’s financial position at a given point in time. Along with an income statement and a cash flow statement, a balance sheet can help business owners evaluate their company’s financial standing. For example, when your company’s current assets are more than its current liabilities, you’re likely in a good position to cover any short-term financial obligations.
2. Compare your business to your competitors
Looking over your balance sheet can also help you determine how you stack up against other businesses in your industry. If you want to improve your company’s financial health, use the balance sheet to determine which financial habits need adjusting to help you compete better. You can use the following ratios to compare your business with others.
- Debt-to-equity ratio: This helps you determine your company’s financial leverage. To use this ratio, divide your company’s total liabilities by its shareholders’ equity.
- Quick ratio: This helps you to determine whether your company has enough current assets that it could liquidate to pay off its current liabilities. To use this ratio, add up your cash and equivalents, marketable securities and accounts receivable. Then divide the sum by current liabilities.
3. Conduct financial health assessments
A balance sheet can help you tracking the performance of your company, for example, your company’s ability to meet financial obligations. In addition, it allows you to compare your current balance sheet to a prior balance sheet to better understand how your company is doing over time. For example, have the assets of your company increased or has your company accumulated more debts?
4. Support an existing or potential investor’s review of your company’s net worth?
Investors use a company’s balance sheet to assess a company’s net worth as part of their review of possible investments. Investors also use the balance sheet to calculate financial ratios to determine a company’s financial standing, including:
- Debt-to-equity ratio: This represents a company’s total liabilities divided by its shareholder equity. See the formula above. The debt-to-equity ratio helps companies and investors determine the degree to which a company is financing its operations through debt vs their own funds.
- Quick ratio: This determines whether a company’s short-term assets or quick assets are sufficient to cover its current short-term liabilities. See formula above.
Tips for preparing a balance sheet
The following tips can help you prepare a balance sheet:
- Determine the reporting date (e.g., December 31) and prepare your balance sheet in regular intervals (e.g., annually) – this will allow you to compare your company’s current financial position to prior periods and track changes.
- List your company’s assets, liabilities and determine which are current and which are non-current – this will help you to better understand what your assets and liabilities are and how best to categorize them.
- Calculate the shareholders’ equity and check that your balance sheet balances – this will help you to spot any errors.
- Use a balance sheet template or example – this will help you with the format.