A balance sheet gives you an overview of your business’ financial standing.
If you run your own business or are just getting into accounting, you’ve likely seen one before. Creating one might seem a bit difficult and daunting, so, in this post, we’ll discuss:
- What is a balance sheet?
- Why is a balance sheet important?
- Balance Sheet Equation
- How to Create a Balance Sheet
- Balance Sheet Examples
- Balance Sheet Templates
- Balance Sheet Analysis
What is a balance sheet?
A balance sheet is a financial statement that shows a company's assets, liabilities, and shareholder’s equity, or how much shareholders have invested.
Line items on each side of your balance sheet are listed in order of liquidity, with the more liquid items (e.g., cash and inventory) listed before accounts that are more illiquid (e.g., plant, property, and equipment).
Here’s an example of what that looks like:
Why is the balance sheet important?
A balance sheet is important because it shows business owners and investors what a company owns and owes during a specific period. A balance sheet for a typical accounting period (12 months) would reflect the number of assets and liabilities when the period ends.
Balance sheets are typically used to track earnings and spending but can also show the profitability of a business to those interested in buying shares.
Balance Sheet Equation
A balance sheet equation shows what a company owns (assets), how much it owes (liabilities), and how much stake or shares owners have in the business (shareholder’s equity). You can calculate it using the following accounting formula:
Assets = Liabilities + Shareholders' Equity
Let’s take a look at each one of these in more detail.
Three Components of a Balance Sheet
A balance sheet consists of three components: assets, liabilities, and shareholders’ equity. Let’s go over these one by one.
Investopedia defines an asset as “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).
Liabilities are the opposite of assets. It’s anything that will incur an expense or cost in the future — a debt or amount owed is a liability. 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
Shareholders' equity, also known as stockholders' equity, is the amount of money the owners have invested in the business. 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
- 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. Determine the time period you're reporting on.
The first step is to choose the reporting date, or when you’re compiling the report, and a reporting period, which is the period of time you’re reporting on. A reporting period usually has already passed.
For example, if your reporting period is Q1 (January 1 - March 31), your reporting date may be April 1 of the same year. Reports are usually created on an ongoing basis, usually on a quarterly frequency.
2. Identify your assets as of your reporting date.
Organize your assets into two categories — current and fixed — and represent each asset as a line item within the appropriate category. Then, subtotal your categories and total them together.
3. 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.
4. 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 your situation requires you to consider any of the following factors:
- Common stock
- Preferred stock
- Treasury stock
5. 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 Example
The image below is an example of a balance sheet.
When you’re ready to begin the process, the templates below can help you start.
Balance Sheet Templates
Below are balance sheet templates that you can use with Microsoft Excel to create one for your business.
What we like:
Toggl’s balance sheet template gives an overview of your balances in one single view. It also has pre-set items for current assets, fixed assets, current liabilities, and long-term liabilities so, you won’t have to add them in yourself.
What we like:
QuickBooks’ balance sheet templates allow for all of the customizations you need to make to tailor it to your own business. It also comes with “Notes on Preparation” tips to help you work through the specific template, and hovering over specific column items brings up instructions to ensure you input the right data.
What we like:
This balance sheet template from Corporate Finance comes with preset items to fill out for your business and an example balance sheet that you can use as a reference when filling one out for your own business.
What we like:
Microsoft’s balance sheet divides your sheet into three key tabs: summary, assets, and liabilities. This helps you keep calculations separate to eliminate confusion and to give you an overview of balances in the summary tab.
What we like:
This balance sheet includes notes for preparation to guide you through the set up and calculation process. It also includes an additional category named “Other Assets,” where you can take into account your business’s intangible assets and deposits.
Now that you’ve created your balance sheet, how do you go about analyzing it? Let’s take a look.
Balance Sheet Analysis
A balance sheet helps you determine your business’ liquidity, leverage, and rates of return. When your current assets are greater than your liabilities, your business is likely in a good financial position and is able to cover your short-term financial obligations.
A balance sheet analysis helps you get a sense of your current standing, and the first step is to look at your balance sheets from two or more accounting periods. If your results show that, say, there’s a significant percent decrease in your company’s cash, you might be experiencing financial problems.
You should also look at:
- Leverage ratio: A leverage ratio is how much of company's capital comes from debt. 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 the value of a business compared to its debt.
- 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. To get a ROA percentage, you’d divide net income by average assets.
These formulas tell investors whether or not they will get a return on the money they invest in your company.
A Balance Sheet Will Help Your Business Grow
The balance sheet 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. It can also help you diagnose problems, pinpoint financial strengths, and keep track of your business’ financial performance over time.
Editor's note: This post was originally published in January 2019 and has been updated for comprehensiveness.