Understanding the Balance Sheet
Understanding your balance sheet is a crucial part of running your business. The balance sheet is one of the three fundamental financial statements. The financial statements consist of the following:
Statement of Cash Flows
The balance sheet is an essential part of your business because it gives you a snapshot of your financial health at a particular point in time. The balance sheet is a statement that displays all of your transactions, summarized since you started your business and began tracking the comp finances.
A balance sheet is broken down into three sections:
Assets (what you own), Liabilities (what you owe), and Owners' Equity (what you have left over).
This statement is sometimes referred to as a "statement of financial position" since it summarizes all of your finances. These statements can be prepared from monthly, to quarterly to annually depending on how often you need them.
What is the purpose of the balance sheet?
The purpose of the balance sheet is to show your overall financial health. It quickly shows you how much cash you have available, how much you have in debt. You might use it to see if you have enough cash to pay your expenses.
The balance sheet is used for key metrics when trying to figure out your debt to equity ratio which is a key financial measure to show you what your ability to pay for your debt with the equity you have accumulated or lost. This helps you decide if you need to raise more equity. The most important metric to know is the current ratio which is the current assets/current liabilities. This calculates if you have the ability to pay for your debts for the next year.
Comparative balance sheets show you how your business compares to prior years. You can examine how you have changed from the previous year or over time.
Balance sheet template
You can download a free template for your small business.
Take a look at the below balance sheet example:
Sections of the balance sheet
The three main categories are:
Assets, liabilities and owner's equity.
Let's take a look at each of these categories.
Assets are what you own in your business. We list the assets in the order of liquidity which means how easy it is to turn them into cash if you need them, sold or consumed.
Current assets are assets that you expect to convert into cash within the next 12 months.
Current assets include:
- Money in checking
- Money that is in transit (wires being transferred to your account from another account)
- Short-term investments
- Prepaid expenses
- Cash equivalents (stocks, bonds or currency)
Long term assets are assets that you plan to keep longer than 12 months
Long term assets include:
- Property & equipment
- Intangibles (patents, trademarks, goodwill)
- Long-term investments
- Deferred tax asset (tax benefits that are prepaid)
Liabilities are what you owe to other people or businesses. They are listed in order of when they are due. Current liabilities are due within the next 12 months.
- Accounts payable
- Wages payable
- Taxes owed (sales taxes or income taxes payable)
Long term liabilities are due longer than 12 months
Long term liabilities include:
- Bonds Issued
- Accrued federal or state income taxes
Equity is money that the company is currently holding. For corporations we list this as stockholders' equity and for limited liability companies owner's equity.
Owner's equity includes:
- Capital (money that you have invested in the business
- Capital stock
- Retained earnings (all of the revenue minus expenses since you started your business)
Equity changes through the years. It increases as you make more money and decreases as your business loses money, dividends are issued to shareholders or you take money out (owner's drawing).
The balance sheet must always balance.
Assets = Liabilities + Owner's Equity
Now that we know what assets, liabilities & owner's equity are, you can get a better understanding of your financial health.
If you're still having trouble with setting up your balance sheet, try our bookkeeping services. We will prepare your financial statements for you and this way, you will know that your numbers are accurate. Book a free consultation with us.