Balance sheets are a basic building block of effective financial analysis. Many accounting applications will even generate one automatically. But that isn’t very useful if you don’t have an understanding of what a balance sheet is and how it can help keep your business healthy. Read on to learn the elements of a balance sheet and how to integrate it into your business strategy.
Building a Balance Sheet
A complete balance sheet lists the company’s assets followed by its liabilities and equity.
There are three types of assets: current, fixed, and intangible. Current assets include the cash in your bank accounts and any items that can easily be turned into cash (like inventory and accounts receivable). Fixed assets are the physical items you use to generate income, such as laptops, manufacturing equipment, and vehicles. Intangible assets include non-physical revenue drivers, such as copyrights, brand value, and website domains.
Liabilities are your company’s obligations. They fall into two categories: current and long-term. Current liabilities consist of any payment due within the next year, like credit card balances, accounts payable, and taxes. Long-term liabilities are often loans (either from entities or individuals), but generally include anything with a payment term longer than one year.
The last section of the sheet is your equity, also known as net worth. Equity is the financial value the company holds for the owner(s) and any stockholders. In other words, if the business closed today and paid off all its debts, how much would be left? You can calculate this by subtracting the total liabilities from the total assets.
If the sheet is done correctly, the total amount of assets should equal the total amount of liabilities and equity.
A very simple balance sheet may look like this:
Accounts Receivable: $4000
Total Assets: $20000
Credit Cards: $4000
Total Liabilities: $11000
Retained Earnings: $9000
Total Liabilities and Equity: $20000
How to Use a Balance Sheet
Balance sheets provide a snapshot of your current financial health, which is critical for gauging the overall health of the company. Along with income statements, they are an essential financial reporting tool for lenders and investors. Used internally, they will help you identify trends and problem areas, making it easier to refine strategy and manage your business overall.
As with the budget, you should examine the balance sheet at regular intervals, ideally once a month. Compare it to the balance sheet from the previous month or past several months. Ask questions like:
- Do you have enough liquid assets to cover an unexpected expense (ex. Equipment failure)?
- Are you paying down credit cards quickly enough?
- Is the business consistently generating value?
- Can you cover immediate expenses without affecting your savings?
- Is your current path sustainable?
You can also compare the current balance sheet to the previous month’s budget to see how close your predictions came to the actual outcome and adjust strategy accordingly.
As with budgets, you don’t have to have an Accounting degree to create an effective balance sheet. With a small investment of time and effort, any business owner can obtain this fundamental business tool.