What Is a Balance Sheet?
A balance sheet is essentially a financial statement that lists and reports a company’s assets, liabilities, and shareholder equity at a specific moment in time. Essentially, this statement is vital to understanding what a company owns and owes and how much has been invested by shareholders.
A balance sheet is produced to reflect a specific moment in time, and the data is used to understand investors’ rate of return and evaluate a business’s capital structure. Balance sheets can also be used alongside other types of financial statements to perform analysis and calculate financial ratios. To understand exactly how balance sheets work and how to use them, please read on.
Why Are Balance Sheets Important?
As a business owner, balance sheets are crucial for understanding the health of your company and the relationship between your different accounts. When you scrutinize a balance sheet, it allows you to see the following:
- Liquidity: This shows you what your current cash flow situation is like. In other words, it’s the amount of money you can gather at a moment's notice. And you should always ensure you have a buffer between your existing assets and liabilities to fulfill any short-term financial obligations.
- Efficiency: If you use your balance sheet in conjunction with your income statement, you can measure the efficiency of your business’s asset use. For example, you can view how well your business utilizes its assets to create revenue.
- Determines risk: By comparing debts to the equity noted on the balance sheet, you can understand how much leverage your company has and, from that, how much financial risk you are up against.
- Secure capital: In order to secure investment, a company must produce a balance sheet for investors so they can assess the financial health of a business.
- Secure talent: Potential and existing employees want reassurance that their jobs are safe and that the business is healthy. The balance sheet allows employees to assess the health of the business and how good its financial decisions are.
Who Is Responsible for the Balance Sheet?
If you have a bookkeeper or an accountant, this individual will be responsible for producing the balance sheet. However, smaller businesses that do not employ any financial staff typically place the business owner in charge of producing the balance sheet.
It’s worth noting here that you do not have to employ full-time financial staff to have balance sheets produced. You can always employ the services of a virtual bookkeeper or accountant to do it for you. For example, EvolveCFO gives you access to financial professionals for this very reason.
Items on a Balance Sheet
So what exactly is on a balance sheet? Here are the main components that make up the bulk of the document.
Assets
Assets are essentially everything the business holds of value that can be converted into cash within a year or less:
- Cash and cash equivalents
- Marketable securities
- Inventory
- Accounts receivable (money customers owe the business)
- Prepaid expenses (advertising and insurance, etc.)
The balance sheet also includes long-term assets that cannot be liquidated within a year:
- Fixed assets (buildings, equipment, machinery, etc.)
- Intangible assets (non-physical assets)
Liabilities
Next we have liabilities. In a nutshell, this is any money the company owes to outside parties, including:
- Accounts payable (money owed on invoices)
- Any portion of long-term debt due within the next 12 months
- Any interest payable on loans
- Wages payable (staff salaries and benefits)
- Customer prepayments (money received by a customer before service or product has been provided)
- Dividends payable
- Earned and unearned premiums (money given upfront but company obligation not fulfilled)
Long-term liabilities include:
- Long-term debt beyond the next 12 months
- Deferred tax liability (taxes accrued but not payable until the following year)
- Pension fund liability
Owners Equities
Finally, we have equities, and this refers to:
- The amount of money the business generates
- The amount of money invested by shareholders and business owners
- Any additional capital paid in
Balancing a Balance Sheet
The clue is in its name. A balance sheet must always be produced balanced. To achieve this, the balance sheet is split into two sections; business assets on one side and liabilities and owner’s equity on the other side.
The two sections must then represent the following formula:
Assets = liabilities + owner’s equity
In other words, the total value of the assets must be the same as the combined value of the liabilities and equity. When this is the case, the balance sheet is considered balanced.
Total assets is the sum of all short-term, long-term, and other assets. Total liabilities is the sum of all short-term, long-term and other liabilities. Total equity is the sum of net income, retained earnings, any capital paid in, and share of stock issued.
Analyzing a Balance Sheet
Balance sheets are typically analyzed through financial ratio analysis. This can take place in one of two ways:
- Financial strength: This explains how effectively a business can meet debt obligations. This analysis also shows debt-to-equity ratios and working capital ratios.
- Activity ratios: This places emphasis on current accounts and operation expenses. This type of analysis also includes payables, inventory, and receivables.
An accountant is qualified and able to use both types of analysis to gain a deeper understanding of your company’s financial health. This means you’re not suddenly expected to understand how financial statements and balance sheets work. You just need to get an accountant on board to do it for you.
However, there’s no need to rush out and try to recruit a financial expert, you can just employ the services of a virtual EvolveCFO accountant here.
At EvolveCFO, we specialize in providing financial support and assistance to new businesses and startups. Our team of qualified accountants is on hand to take care of your day-to-day financials, bookkeeping tasks, and any financial analysis you require to help your business grow.