Most business owners look at financial reports as something they have to complete for administrative reasons. They usually pass this task to their accountant without understanding its implication. So what is a balance sheet? The answer is not a report your accountant periodically provides for you to file. The balance sheet provides information on your company's financial health at a specific point in time. It assesses your business: income, debt, and value. It is also part of a bigger report that helps you manage your company effectively.
What Is a Balance Sheet?
A balance sheet is a financial document that outlines your business assets, liabilities and stockholder's equity. Assets are the things the business owns, liabilities are what the company owes, and stockholder's equity shows how the business is working for its owners. Though the various line item details for each section may differ, the balance sheet has a standard format. If you use a two-column report, the assets are in the first column and liabilities and stockholder's equity are in the second column. If you use a single-column report, then list the components in the following order: assets, liabilities, and stockholder's equity.
What Is a Balance Sheet: The Assets
Your company assets fall under two categories: current assets and noncurrent assets. Current assets help pay operational expenses such as rent, wages, and the cost of doing business. Non-current assets do not support the day-to-day business operations, but they add value to your business over time. Your balance sheet report will first display the current assets and their total, followed by the non-current assets.
The Assets: Current Assets
Current assets are the assets that easily convert to cash within your company's operational period which is usually a year. Your current assets show how long the business could run without additional revenue. Some current asset examples include cash, cash equivalents, account receivables, and prepaid expenses. Cash includes undeposited cash and checks, money in your business checking and savings accounts, and petty cash. Cash equivalents are any financial instrument you can convert to cash—marketable securities, money market funds, and treasury bills are examples.
The account receivables subcategory equals all the money you expect to receive for rendered services or products your customers have in their possession but have an outstanding balance. Prepaid expenses are the companies you pay in advance. For instance, if you pay for insurance for a year, and your reporting in month three, then you would report nine months' worth of your premium under prepaid expenses. Prepaid expenses can get tricky. If your yearly premium does not align with your operational period, then you would report any prepaid expenses for the next operational period under noncurrent assets.
The Assets: Noncurrent Assets
All assets that cannot convert to cash within 12 months are noncurrent or long-term assets. The majority of your noncurrent assets generate benefits over several operational periods. Your noncurrent assets appear below your current assets, grouped by asset type. Examples of noncurrent asset categories include property, plant & equipment, long-term investments, and intangible assets.
Property, plant, and equipment include work vehicles, buildings, office and production machinery, and furniture. Your long-term investments total may consist of common stock purchases, long-term notes, bonds, and pension funds. Intangible assets do not have a physical form, but they have future expected value. Assets like patents copyright, goodwill, and trademarks are intangible assets.
What Is a Balance Sheet: The Liabilities
Liabilities are the debts you incur to operate and invest in your business. Your liabilities appear in the second column of a two-column balance sheet report. Your liabilities fall under two categories: current and noncurrent liabilities. Non-current liabilities are the amount you owe outside your current operational cycle. List your current liabilities and total current liabilities before noncurrent liabilities.
The Liabilities: Current Liabilities
Current liabilities include operational expenses and short-term loans. It shows how much you owe and the corresponding current assets give insight on whether you can pay the debt. Common current liabilities include accounts payables, taxes, and fees. Your balance sheet's accounts payable total includes short-term debt for items like inventory and office supplies. For instance, you may have a net-30 account with your office supply vendor. Taxes payable include payroll, income tax, and sales tax you collected for the current year. Fees encompass payments for overdrafts, late payments or overdraft fees. Current liabilities also include rent, wages, and short-term loans.
The Liabilities: Noncurrent Liabilities
Non-current liabilities are debt obligations due in a future operational cycle. Capital lease, notes payable and mortgage payable are examples. Like assets, debt obligations for an account can map to a current liability and a noncurrent liability. Any debt obligation due in the current year is a current liability and any portion of the debt obligation due in a future year is a noncurrent liability.
The stockholder's equity helps you calculate your company's book value. List all stockholder equity accounts and the subtotal below noncurrent liabilities. The stockholders' equity is the amount of money left over after the company pays all its debt. Common sections in the equity Stockholder's equity section includes paid-in capital, retained earnings, treasury shares, and common stock. The paid-in capital total shows how much your investors contributed to your company. Typically you fund capital purchases by using the equity or long-term debt. Retained earnings are the gains from the investment.
Is There a Need for a Balance Sheet?
If you are wondering what is a balance sheet, you may also be asking yourself if you need a balance sheet. The answer is yes. as It measures your business health. While a balance sheet only gives you a snapshot of how your business is doing, comparing periods can help you spot trends. Investors and banks require a balance sheet so they can assess how your business is doing. Last, the balance sheet helps you manage your business and make strategic decisions.
What Is a Balance Sheet: Financial Ratios
Use the financial numbers on your balance sheet to analyze the relationship between two numbers or the financial ratios. Financial ratios are powerful assessment tools that help you make informed decisions and ask your management staff right questions. The current ratio and quick ratio measures are two liquidity ratios.
Financial Ratios: Current Ratio
The current ratio measures your ability to pay your short-term liabilities. It is one of the liquidity ratios because it shows if you have enough cash available to pay your business bills. Calculate current ratio by dividing total current assets by total current liability. If your current ratio is less than 1.0, it indicates you cannot meet your operational expenses. If you have a ratio of over 2.0, investigate further to understand why.
Financial Ratios: Quick Ratio
The quick ratio (acid-test ratio) tries to correct flaws in the current ratio by removing inventory, prepaid expenses, and supplies; however, it has flaws of its own. It leaves in accounts receivables, hence assuming all of your clients pay their outstanding debt on time. The quick ratio is not a great indicator for industries that have high inventories. Keep in mind that ratios are one of a set of tools to help you conduct a business financial checkup.
How to Create a Balance Sheet
The balance sheet organizes your business financial health in a format that allows you to tell the story. Make sure you include assumptions, notes, and any other supplemental information you need for a thorough analysis. Reports like a cash flow statement and income statement assist in the full analysis. In addition to knowing what is a balance sheet, you need to know how to create one.
The balance sheet accounts for all your company assets, liabilities, and earning must balance.
Include your company name, report name (e.g., balance sheet), and the report "snapshot" date.
Increase readability by aligning the following right and left column lines:
Your asset column starts with the current assets, followed by the long-term assets, and then the total. The categories depend on your company policies. You may have several subtotals, for instance: total current assets, total property, plant & equipment (less accumulated depreciation) and total intangible assets.
What Is a Balance Sheet: Completing the Financial Package
Include supporting information in your final report. Small businesses should also include an income statement and a statement of cash flows. Your appendix will have ratio calculation, assumptions, explanations and anything else that helps you make informed decisions.
What Is a Balance Sheet: Conclusion
So, hopefully, you now have a better understanding of 'what is a balance sheet?' Your balance sheet is part of a bigger financial analysis, and it helps you determine your company's financial grade. You do not have to create a manual report. Your accounting system can produce the report for you; however, it is only as accurate as the information in it. Knowing how to compile and interpret a balance sheet will allow you to make informed decisions.