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.
If you run your own business or are just getting into accounting, creating a balance sheet could seem difficult. No worries. In this post, 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 one side, the company's assets are reported. The other 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) listed before accounts that are more illiquid (e.g., plant, property, and equipment).
Why is the balance sheet important?
The balance sheet is important because it tells business owners and investors what the company owns and what it owes. While its primary use is to track earnings and spending, it can also be an excellent tool to show the profitability of a business to those who are interested in buying a share.
The balance sheet provides a snapshot of the business' financial standing at a specific 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.
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 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).
A liability is the opposite of an asset. It’s anything that will incur an expense or cost in the future — for example, 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.
This template from Toggl offers an overview of your balance in a handy one-tab format — there’s no need to click from tab to tab to fill it out. It also has pre-set items for current assets, fixed assets, current liabilities, and long-term liabilities. You also won’t have to fill in the types of assets and liabilities you’d like to take into account.
QuickBooks’ balance sheet template comes with a completely blank version for utmost customization. We recommend starting with the example, duplicating the tab, and editing it to tailor it to your business. It also comes with a handy “Notes on Preparation” box that gives you a step-by-step tutorial on working with this template specifically. When you hover over the column items, it also gives you more instructions for filling it out.
This downloadable template from the Corporate Finance Institute comes with preset items to fill out for your business. Like in Toggl’s template, you won’t need to fill out each asset or liability you’d like to list. It comes pre-loaded with an example balance sheet, which you can then duplicate before customizing it for your business.
Microsoft Office 365’s balance sheet divides your sheet into three tabs: summary, assets, and liabilities. That way, you can keep calculations separate, and quickly scan the summary tab for the final balance. It also includes a “Categories” tab where you can get a refresher on the categories for each balance item.
Score.org is a resource organization for small businesses and new entrepreneurs. They offer a balance sheet that, like the Corporate Finance Institute’s, includes notes on preparation for easy set up and calculations. 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
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.
First, perform a comparative analysis by looking at the balance sheets 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.
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 the 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.
Originally published Apr 14, 2021 2:00:00 PM, updated April 14 2021