What Is a Balance Sheet?
Knowing what a balance sheet is crucial. You can find our sample balance sheet at the end of the article.
A balance sheet is a snapshot of the financial condition of a business at a specific moment in time, usually at the close of an accounting period.
A balance sheet comprises assets, liabilities, and owners’ or stockholders’ equity. Assets and liabilities are divided into short- and long-term obligations, including cash accounts such as checking, money market, or government securities.
At any given time, assets must equal liabilities plus owners’ equity. An asset is anything the business owns that has monetary value. Liabilities are the claims of creditors against the assets of the business. So when you create a balance sheet, you must make sure that it balances. The way you do this is by increasing or decreasing the liabilities’ side of the sheet so that it equals the assets’ side. More specifically, the part of the liabilities’ side that you adjust is the owners’ equity.
It might sound as if owners’ equity falls under the category of liabilities, but essentially you can think of it as the value that is owed from the business to the owners. In other words, you carefully add up the assets on the left side of the balance sheet and then add up all of the liabilities on the right side of the balance sheet and then subtract the liabilities from the assets. The net number is the owners’ equity. It is, of course, possible that the owners’ equity is negative if the liabilities are greater than the assets.
If you are wondering what a balance sheet is, maybe you should also check out our article about income statement. What is an income statement?
What Is a Balance Sheet Used For?
A balance sheet helps a small business owner quickly get a handle on the financial strength and capabilities of the business. Without a balance sheet accounting is impossible. Is the business in a position to expand? Can the business easily handle the normal financial ebbs and flows of revenues and expenses? Or should the business take immediate steps to bolster cash reserves?
Balance sheets can identify and analyze trends, particularly in the area of receivables and payables. Is the receivables cycle lengthening? Can receivables be collected more aggressively? Is some debt uncollectable? Has the business been slowing down payables to forestall an inevitable cash shortage?
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Balance sheets, along with income statements, are also the most basic elements in providing financial reporting to potential lenders, such as banks, investors, and vendors who are considering how much credit to grant the firm. Keep in mind that if you are a corporation or a limited liability company, then the assets and liabilities on your balance sheet (except for the owners’ equity) are not personal assets and liabilities of you or your partners. Similarly, if you are a sole proprietorship, then what matters is your personal balance sheet, because the business does not exist as a separate legal entity.
How Do I Format a Balance Sheet?
Assets are subdivided into current and long-term assets to reflect the ease of liquidating each asset. Cash, for obvious reasons, is considered the most liquid of all assets. Long-term assets, such as real estate or machinery, are less likely to sell overnight or have the capability of being quickly converted into a current asset, such as cash.
- Current assets: Current assets are any assets that can be easily converted into cash within one calendar year. Examples of current assets are checking or money market accounts, accounts receivable, and notes receivable that are due within one year’s time.
- Cash: Money available immediately, such as in checking accounts, is the most liquid of all short-term assets.
- Accounts receivable: This is money owed to the business for purchases made by customers, suppliers, and other vendors.
- Notes receivable: Notes receivable that are due within one year are current assets. Notes that cannot be collected on within one year should be considered long-term assets.
- Long-term assets: Long-term assets include land, buildings, machinery, and vehicles that are used in connection with the business.
- Land: Land is considered a fixed asset but, unlike other fixed assets, is not depreciated, because land is considered an asset that never wears out.
- Buildings: Buildings are categorized as fixed assets and are depreciated over time.
- Office equipment: This includes copiers, fax machines, printers, and computers used in your business.
- Machinery: This figure represents machines and equipment used in your plant to produce your product. Examples of machinery might include lathes, conveyor belts, or a printing press.
- Vehicles: This includes any vehicles used in your business.
- Total fixed assets: This is the total dollar value of all fixed assets in your business, less any accumulated depreciation.
- Total assets: This figure represents the total dollar value of both short-term and long-term assets of your business.
Related: It Is Possible to Start a Business With $10000!
Liabilities and Owners’ Equity
This includes all debts and obligations owed by the business to outside creditors, vendors, or banks that are payable within one year, plus the owners’ equity. Often, this side of the balance sheet is simply referred to as “liabilities.”
- Current liabilities: This is the sum total of all current liabilities owed to creditors that must be paid within a one-year time frame.
- Accounts payable: This is comprised of all short-term obligations owed by your business to creditors, suppliers, and other vendors. Accounts payable can include supplies and materials acquired on credit.
- Notes payable: This represents money owed on a short-term collection cycle of one year or less. It may include bank notes, mortgage obligations, or vehicle payments.
- Accrued payroll and withholding: This includes any earned wages or withholdings that are owed to or for employees but have not yet been paid.
- Long-term liabilities: These are any debts or obligations owed by the business that are due more than one year out from the current date.
- Mortgage note payable: This is the balance of a mortgage that extends beyond the current year. For example, you may have paid off three years of a fifteen-year mortgage note, of which the remaining eleven years (excluding the current year) are considered long term.
- Owners’ equity: Sometimes this is referred to as stockholders’ equity. Owners’ equity is made up of the initial investment in the business as well as any retained earnings that are reinvested in the business. Remember, total liabilities, including owners’ equity, must equal the assets. The way you achieve balance is by totaling up all the assets of the business, and then you subtract all of the liabilities except for owners’ equity. The remaining amount is the owners’ equity.
- Common stock: This is stock issued as part of the initial or later-stage investment in the business. This stock remains fixed at its initial valuation on the company’s books.
- Retained earnings: These are earnings reinvested in the business after the deduction of any distributions to shareholders, such as dividend payments. Retained earnings are determined by subtracting common stock from the owners’ equity.
- Total liabilities and owners’ equity: This comprises all debts and monies that are owed to outside creditors, vendors, or banks and the remaining monies that are owed to shareholders, including retained earnings reinvested in the business.
Balance Sheet Example
Before creating your own balance sheet, check out our template balance sheet! You can also click on the print button below to get your own downloadable balance sheet.
Getting your balance sheet together is just one step of starting your own business. What are the other steps? Check them out here: How to Start a Business in 5 Steps