Published September 03, 2020
The balance sheet is one of the three most important financial statements for business owners, and includes assets, liabilities and shareholder equity.
A balance sheet lists a business's total assets, debts and shareholder equity, providing a look into the company's financial position at a specific point in time. Often described as a snapshot of performance, the balance sheet may be overlooked by time-crunched business owners – but it shouldn't be. The balance sheet is extremely important to assess where your business has been and where it's going, and it can help you determine if you need to borrow money or if you're in a position to pursue growth.
What is a balance sheet?
The balance sheet is one of the three main types of financial statements that are vital to business owners' success. The other two are the income statement and the cash flow statement.
For a balance sheet to be an effective forecasting tool, it has to include key components, such as your company's assets (what it owns) and its liabilities (what it owes). The balance sheet also notes shareholder equity (or owners' equity), or how much shareholders have invested in the business.
"So many small businesses, particularly mom-and-pops, only look at how much cash they have in the checking account and if they have enough money to pay their bills," Mitchell Freedman, a certified public accountant and personal financial specialist at MFAC Financial Advisors, told business.com. "That may be fine for some businesses, but if somebody wants to understand their business, the balance sheet provides a lot of information."
What's included in a balance sheet?
Although it can differ from one industry to the next, the balance sheet typically consists of three main parts: assets, liabilities and shareholder equity.
The assets section lists both liquid assets, or those you can easily access for cash, and fixed assets, otherwise known as nonliquid assets.
Fixed assets are things of value that you can't turn into cash quickly, such as property, an office building or equipment used in operations.
There are also intangible assets that aren't physical but bring value to the business. They include the business's goodwill, brand name, intellectual property and patents, among other things.
Put all of those holdings together, and you have your list of total assets for the balance sheet.
Liabilities are all of your business's debts, including mortgages, bank loans, expenses and any other obligations. They're typically broken down into current and long-term liabilities.
Current liabilities are those due during the year. Office supplies, rent, marketing expenses, payroll, taxes, loan payments and healthcare costs are some examples of current liabilities.
Long-term liabilities are any debts not due within a year. They can include debt obligations, deferred tax liabilities and bond payments.
Take a bank loan, for example. If you're required to pay it back in less than a year, it would fall in the current liabilities category. If it's due further than a year out, it's considered a long-term liability.
Shareholder equity, also known as owners' equity, is the amount of money the business owner would get if the business assets were liquidated and all of the debts were paid off. It doesn't include retained earnings, or the money the business keeps to pay off debt or reinvest in operations.
Understanding owners' equity on the balance sheet can help investors gauge how the business is performing from a financial perspective. Shareholder equity goes up as sales increase. The more cash a small business has, the larger the financial cushion is.
Why does the balance sheet matter?
Small business owners may not think they need balance sheets, but there are several reasons why these financial statements matter a lot.
For starters, balance sheets can tell you what your account receivables are if you sell a service or merchandise on credit, and they reflect all of the liabilities, providing a snapshot of how your business is doing.
Additionally, a balance sheet provides you with the necessary data if you want to compare your business metrics with those of similar enterprises. According to Freedman, resources abound on the internet for companies to compare themselves with competitors.
"If you're in the top quartile, you're sitting pretty, but if you're in the bottom quartile, you could face potential problems," Freedman said. "Take what happened in the last several months with the pandemic closing down businesses. Those who understood what they had and accumulated sufficient capital were able to withstand the stresses and strains."
Balance sheets also come in handy when determining if you need to take on more debt to grow operations or reduce the interest rate on your existing debt.
Balance sheet examples
Whether you're using Microsoft Excel, Google Sheets or accounting software to create your balance sheet, make sure to put your business's name and the current year at the top.
The first column should list your current assets, detailing what they are and how much each is worth. At the bottom of that column, note the total amount of current assets. Next, list total fixed assets. In this column, detail fixed assets and the total amount. Your other assets, or intangible assets (such as goodwill), go below the current and fixed assets. Combine all three columns to determine your total assets.
Do the same with liabilities. List all of your current liabilities and long-term liabilities in separate columns to come up with your total liabilities. The final column on the balance sheet includes owners' equity and net profit.
Source: Image courtesy of SCORE.
Source: Image courtesy of SBA Complete.
What are the best practices for working with a balance sheet?
There are several ways to craft a balance sheet, but if it's missing certain elements, it won't be worth the paper it's printed on. That's why it's important to spend the time to make sure all of your assets are represented on the balance sheet, including intangible assets, and all debt obligations.
"I'm a big fan of small business owners having a balance sheet that shows their cash accounts, their accounts receivable, their inventory and their investments," said Dennis Sherrin, a certified public accountant and past chairman of the Alabama Society of CPAs. "It should also show capital, assets and whatever is needed to operate the business, as well as what they owe. It should give them a reflection of how they are doing at any point in time."
Depending on your comfort level and available time, you can create and update the balance sheet on your own, hire an accountant or use accounting software. Sherrin is a big fan of the latter, since most accounting software is cloud-based these days, making it accessible to you, and potentially your accountant, at any time. That means you can get a sense of your financial health on the go. This software should also connect to your bank accounts, so the balance sheet can be updated in near real time.
"The old ways are very old now," Sherrin said. "I'm an advocate of having your accounting records in a cloud system."