The balance sheet is essentially the “statement of position” of the company. The regular review and analysis of the financial position of your company is important in keeping your business on the right track. Without the knowledge of the economic health and investment return of your company, it is much more difficult to make wise decisions. As a business owner, you know your business’ operations like the back of your hand, but equally important is the knowledge about financial statements and what information they provide.
What is a Balance Sheet and How to Prepare It
A balance sheet is a financial statement containing the information about all the assets (what the company has/owns), liabilities (what the company owes), and shareholder’s equity (what is left after paying the obligations/liabilities) at any specific point in time.
A balance sheet is also used as a source of information for the investors to learn about the financial situation of the business. A simple balance sheet for your company can be done easily by following these steps:
- Determine the specific date that the balance sheet will be presented
- Make a list of the assets of your business—cash balances, savings account balances, inventories, accounts receivable, machinery, furniture, etc. (pro tip: do some further research on current and non-current assets, and why they are categorized as such)
- Make a list of your business’ liabilities (including accounts payable, bank loans, credit cards, tax payable, pending wages, etc.)
- Subtract your company’s liabilities from your company’s assets to derive the equity balance
Now, refer to this equation:
Assets = Liabilities + Equity
Make sure that equation is satisfied (hence the term “balance sheet”, as it has to balance). The equity amount should be positive and demonstrate that the company is able to meet its obligations with the resources available. A negative equity balance is a big red flag, and if you have one, you should seek professional financial advice.
What Are Balance Sheet Accounts?
A balance sheet account is the categorization of the financial information—a grouping of information together—to form an account. This is how you accurately manage your financial information. For example, all the businesses and suppliers that the company owes money to are categorized into an account called “Accounts Payable”. A business may have debt (money owed) to multiple lenders, so these are categorized together into an account called “Financial Obligations” and so on. This way, the balance sheet becomes organized and much easier to understand.
Benefits of Using a Balance Sheet
Analyzing your company’s balance sheet allows you to track your investments and obligations, allowing you to know your financial position and potential in the market. Moreover, it also helps you to identify problems at early stages, or issues that could become much more problematic later if left unattended. As discussed, the fundamentals behind a balance sheet aren’t complicated, and it’s a powerful tool to help you handle the finances in your business. Some benefits of a balance sheet include:
Tracks Your Investments and Returns
The balance sheet helps you to list all assets and investments, allowing you to track the returns from the investments made by the business. It also allows you to determine the timeline of the investments and their liquidity levels, as well as the time of expiration of your liabilities so that you can better plan the payments of your obligations. Assets and investments are funded by equity and/or debt. Some options are more expensive than others (debt is generally cheaper than equity) and the balance sheet allows you to see and evaluate what is the best way to fund your assets and investments.
Evaluates the Financial Health of Your Company
A balance sheet not only enables you to manage your finances, but it’s also helpful for the outside investor to determine the current position and fate of their investment. Additionally, it carries information about the financial state of your business and, when properly elaborated, the historical evolution of it. For example, updating your balance sheet regularly will help you to know your current financial position, how you’re funding your assets, and, very importantly, the trend of your company (when comparing the differences between multiple balance sheets over time). Are your debts getting smaller? Are they costing more? Is your equity growing (this is obviously the long-term goal)? Based on this, you will gain valuable information to make better decisions for your business.
As a business owner, it’s a part of your responsibilities to keep an eye on investments, assets, cash flow, business productivity, and liabilities. Checking those metrics without a balance sheet makes your work a lot harder and it could lead to poor decision making.
Also, regularly updating the balance sheet allows you to provide more accurate information to your potential investors; when you don’t have records to show to the investors, it’s much more difficult to close a deal. It’s an excellent practice if you consistently make a balance sheet and utilize the data from it.