A balance sheet is one of the key ways that you, as a small business owner, can assess and analyze your company’s financial health and share this information with others, such as your investors (or potential investors). It’s a snapshot of your company’s financial condition at a particular point in time, usually drawn up on a quarterly and annual basis.
The three main sections of the balance sheet are assets, liabilities, and equity. You may remember these three key terms from the accounting equation we covered in a previous blog post, “What is an accounting transaction?,” where assets = liabilities + owner’s equity. Essentially, assets are the resources owned and controlled by your company (such as cash, equipment, and real estate) and liabilities are debts the company owes (such as a loan from the bank). Owner’s equity is the owner’s stake in the company. (There is also shareholders’ equity when the company is a legal corporation.) The “balance” part of “balance sheet” comes into play in the sense that these three sections must remain balanced in order for the balance sheet to accurately reflect your business’ finances.
What does a balance sheet look like?
First, you’ll list your company’s assets in order of liquidity, starting with those that are the most liquid (i.e. the easiest to sell and convert into cash) to the least liquid (i.e., things like real estate that take usually take a long time to convert into cash). Your current assets (those that can be sold off within one year) are the most liquid: current assets include your business’ checking account and Accounts Receivable (for more on Accounts Receivable, check out “Accounts Receivable vs Accounts Payable“). Next come the long-term or fixed assets, those that require more time (i.e. longer than a year) and effort to liquidate, such as real estate, equipment, and land.
Moving to the other side of the accounting equation, next on the balance sheet we will list our liabilities, which are also listed in order of liquidity: short-term liabilities, like bills that need to be paid to vendors and suppliers (otherwise known as Accounts Payable) are the most liquid, followed by longer-term liabilities, such as that loan you took out from the bank and will pay off over a longer period of time.
Next, we have owner’s equity and/or shareholders’ equity. As we saw before, this is the owner’s and shareholders’ stake in the company. The value of shares can be found by multiplying the total number of shares issued by the price per share. Finally, we can add reinvested or retained earnings: this is your net profit after subtracting your operating costs and overhead.
Why is a balance sheet important?
As a small business, your balance sheet is the best way to analyze trends in the financial performance of your business over time. It’s also a great way to organize and report that information to others. (Profit and Loss statements are another important source of information, which is a topic we’ll cover soon!) Your balance sheet gives you a good idea of your company’s financial strengths and weaknesses and that helps you plan the growth of your company. Should you be thinking of expanding rapidly? Or maybe you should be conservative with growth plans? How strong is your cash flow? (You can read more on cash flow on our blog post, “What is Cash Flow and Why is it so Important?“)
For a more in-depth look at the balance sheet, head over to our support article: Balance Sheets.
As always, if you have any questions, feel free to drop us a line at firstname.lastname@example.org!