Whether you're doing your own accounting with accounting software, or you hired an accountant to prepare your financial statements, you've likely seen the balance sheet. The balance sheet, along with the income statement and statement of cash flows provides an overview of a business' financial standing.
Why is the balance sheet important? It's used by business owners and investors to see what the company owns and what it owes, and its primary use is to track earnings and spending. The balance sheet provides a snapshot of the business' financial standing at a specific point in time.
Next, we'll demystify the balance sheet and look at some templates you can use to create your own.
What Is a Balance Sheet?
A balance sheet is one of the key financial statements used for accounting and it's divided into two sides. On the left side, the company's assets are reported. The right side shows the business' liabilities and shareholders' equity.
The line items for each side are listed in order of liquidity, with the more liquid items (e.g., cash and inventory) are listed before accounts that are more illiquid (e.g., plant, property, and equipment).
The balance sheet is a snapshot of the business' financial standing at a single point in time. For example, an accounting period is typically 12 months long. The line items or accounts on the balance sheet would reflect the number of assets and liabilities at the final moment of the accounting period.
How to Create a Balance Sheet
Understand what components you need to include and their functions.
Determine the time period you're reporting on.
Identify your assets as of your reporting date.
Identify your liabilities as of your reporting date.
Calculate shareholders' equity.
Compare total assets against liability and equity.
1. Understand what components you need to include and their functions.
Here are the elements that are required on your balance sheet:
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
2. Determine the time period you're reporting on.
Since a balance sheet's primary role is for reporting, you'll be compiling these on an ongoing basis — most likely on a per quarter frequency.
Choose the date that you'll be compiling the report. This will be your reporting date.
On the reporting date, you'll be looking back at the numbers for a previous time period, one that has already resolved. This time period is called your reporting period.
For example, if your reporting period is Q1 (January 1 - March 31), your reporting date may be April 1 of the same year or another date depending on your needs.
3. Identify your assets as of your reporting date.
Organize your assets into two categories — Current and Noncurrent — and represent each asset as a line item within the appropriate category.
Then, you'll subtotal your categories and total them together.
4. Identify your liabilities as of your reporting date.
These will also be represented as individual line items within Current and Noncurrent categories.
Then, you'll subtotal and total these the same way you did with your assets.
5. Calculate shareholders' equity.
You'll then want to incorporate the share capital you receive from investors as well as retained earnings. You may need to consider if the following must be factored in depending on your situation:
6. Compare total assets against liability and equity.
On the balance sheet, assets equal liabilities plus shareholders' equity. You'll want your balance sheet to include this calculation to provide insights into your financials.
Balance Sheet Equation
The balance sheet equation is used to show what a company owns (assets), how much it owes (liabilities), and how much stake or share the owners have in the business (shareholders' equity). It's calculated with the following formula:
Assets = Liabilities + Shareholders' Equity
Balance Sheet Example
On the balance sheet, you can see how assets, liabilities and shareholders' equity are reported. Here's an example that shows the layout of a balance sheet:
The common size balance sheet is a balance sheet that includes another column specifically for the relative percentage of each line item compared to total assets, total liabilities, and shareholders' equity. It's helpful when performing an industry analysis as the percentages for different companies can be compared.
The balance sheet is key to determine a business' liquidity, leverage, and rates of return. When current assets are greater than current liabilities, this means the business can cover its short-term financial obligations and is likely in a good financial position.
The term leverage is used to describe how much of a company's capital comes from debt. But how does the balance sheet impact a business' leverage? One of the leverage ratios, the debt to equity ratio, divides liabilities from shareholder's equity to show how leveraged a company is.
Other calculations, like return on equity and return on assets, can be calculated with the financial information listed in the balance sheet. Both of these formulas tell investors whether or not they will get a return on the money they invest in the company.
An analysis can also be performed by looking at the financial statements from two or more accounting periods. For example, if there's a significant percent decrease in the company's cash, it could be experiencing financial problems, and it might not be wise to invest in the business.
The balance sheet is one of the three financial statements that provides an overview of your business' financial standing. If your business is doing well, investors can look at your balance sheet and see if you have a profitable business they'd like to invest in.
Originally published Jun 10, 2020 2:15:00 PM, updated June 10 2020