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.
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 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
On the balance sheet, assets equal liabilities plus shareholders' equity. The balance sheet equation is:
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
Balance Sheet Analysis
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.
Next, we'll take a look at some balance sheet templates you can use to create your own balance sheet and perform a financial analysis.
Balance Sheet Template
Below are a few balance sheet templates you can use to create your own.
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 common size balance sheet isn't required under the generally accepted accounting principles (GAAP).
The percentages listed on the common size balance sheet can be used by investors to compare the financial standing of different businesses in the same industry. An analysis can also be performed for a single company 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.