Keeping a balance sheet gives you a good idea of how your business is doing financially.
Whether you run your own business or are just starting out in accounting, you've probably seen one before. Our goal in this post is to make the process as simple and straightforward as possible, so let's get started:
What is a balance sheet?
The balance sheet shows a company's assets, liabilities, and shareholder equity, or how much shareholders have invested.
On your balance sheet, line items are arranged in order of liquidity, with more liquid items (e.g., cash and inventory) listed before illiquid items (e.g., plant, property, and equipment).
To demonstrate what that looks like, here is an example:
Why is the balance sheet important?
Balance sheets are important because they show what a company owns and owes over a specified period. A balance sheet would show the assets and liabilities at the end of a typical accounting period (12 months).
In addition to tracking earnings and expenses, balance sheets can also be used to show how profitable a business is.
Balance Sheet Equation
Balance sheet equations show what a company owns (assets), what it owes (liabilities), and how much stock owners own (shareholder equity). The following accounting formula can be used to calculate it:
Assets = Liabilities + Shareholders' Equity
Let's examine each of these in more detail.
Three Components of a Balance Sheet
The balance sheet consists of three components: assets, liabilities, and shareholders' equity. Let’s go over these one by one.
1. Assets
The Investopedia definition of an asset is "Anything of value that can be converted into cash." In other words, an asset provides economic value to businesses and organizations. Assets include both current assets and fixed assets.
- Current assets: cash and cash equivalents (e.g., short-term government bonds, treasury bills, and money market funds), accounts receivable, and inventory.
- Fixed assets: property, plant, equipment, long-term investments, and intangible assets (e.g., patents and licenses).
2. Liabilities
Liabilities are the opposite of assets. A liability is anything that will result in a future expense or cost - a debt or amount owed. Both current and non-current liabilities are included in the liabilities section of the balance sheet.
- Current liabilities: accounts payable, notes payable due within the year, and current maturities of long-term debt.
- Non-current liabilities: long-term notes payable, deferred tax liabilities, bonds payable, and long-term debt.
3. Shareholders' Equity
A company's shareholders' equity, also known as stockholders' equity, is the amount of money that the owners have invested in the company. It includes:
- Share capital: the amount of money a company receives from its shareholders for business purposes.
- Retained earnings: the amount of a company's profits that aren't distributed to shareholders as dividends — the funds are reinvested in the business instead.
With this information in mind, let’s go over the step-by-step process of creating a balance sheet.
How to Create a Balance Sheet
1. Determine the time period you're reporting on
In the first step, choose a reporting date, which is when you are compiling the report, and a reporting period, which is when you are reporting. Usually, a reporting period has already ended.
The reporting date may be April 1 of the same year if your reporting period is Q1 (January 1 - March 31). Typically, reports are created on a quarterly basis.
2. Identify your assets as of your reporting date
You should organize your assets into two categories - current and fixed - and represent each asset as a line item within the appropriate category. Add up the subtotals of your categories.
3. Identify your liabilities as of your reporting date
Additionally, these will be represented as individual line items within current and noncurrent categories. Subtotal and total these as you did with your assets.
4. Calculate shareholders' equity
As well as retained earnings, you'll need to take into account the share capital you receive from investors. Consider the following factors if your situation requires it:
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Common stock
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Preferred stock
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Treasury stock
5. Compare total assets against liability and equity
Assets equal liabilities plus shareholders' equity on a balance sheet. This calculation should be included in your balance sheet so that you can see how your finances are doing.
Balance Sheet Example
A balance sheet is shown in the image below:
The templates below can help you get started when you're ready.
Balance Sheet Templates
You can create a balance sheet for your business using the templates below using Microsoft Excel.
What we like:
Toggl's balance sheet template provides a single view of all your balances. There are also pre-set items for current assets, fixed assets, current liabilities, and long-term liabilities, so you don't have to add them yourself.
What we like:
You can customize QuickBooks' balance sheet templates to fit your business' needs. There are also "Notes on Preparation" tips to guide you through the specific template, and hovering over specific column items brings up instructions.
What we like:
Corporate Finance's balance sheet template comes with pre-filled items for your business and an example balance sheet you can use as a guide when filling out your own.
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Score.org Balance Sheet
What we like:
Notes for preparation guide you through the process of setting up and calculating the balance sheet. Your business's intangible assets and deposits are also included in the category "Other Assets.".
How do you analyze your balance sheet now that you've created it? Let’s take a look.
Balance Sheet Analysis
Using a balance sheet, you can figure out your business' liquidity, leverage, and rate of return. An organization with more assets than liabilities is likely to be in a good financial position and be able to meet its short-term financial obligations.
In order to get a sense of where you stand, you need to review your balance sheets from two or more accounting periods. You might be experiencing financial difficulties if your results show a significant drop in your company's cash.
Additionally, you may want to consider:
- Leverage ratio: A leverage ratio is how much of a company's capital comes from debt. What is the impact of a company's balance sheet on its leverage? The debt to equity ratio shows the value of a business compared to its debt by dividing liabilities by shareholders' equity.
- Return on equity: Return on equity tells you the percentage of returns from equity investments. To get an ROE percentage, you’d divide net income by the total shareholders’ equity.
- Return on assets: Return on assets shows you the value or profitability of a business in relation to its assets. Divide net income by average assets to get ROA percentage.
Investors use these formulas to determine whether their money will be returned.
A Balance Sheet Will Help Your Business Grow
An overview of your business' financial position can be found on the balance sheet. You can show investors your balance sheet if you have a profitable business they'd like to invest in if your business is doing well. Additionally, it can help you diagnose problems, pinpoint financial strengths, and keep track of your business' financial performance.