Listen to this articleA business must have a detailed balance sheet – it keeps accurate records of the company’s accounts, like assets, liabilities, and equity. It is probably one of the most valuable documents a company can utilize to look into its financials and find the scope for improvement.
Let us understand what exactly a balance sheet is, its essential components, and its importance for a business. Moreover, we will take a look at how to prepare a balance sheet and a sample template for it.
Knowing the Balance Sheet
A balance sheet is a document containing a brief overview of the business’s assets, liabilities, and equity.
Therefore, it gives a glimpse of the company accounts and lets the management know where the company’s money lies. Reviewing the balance sheet allows them to track the cash flow of the business.
A company might need to present its balance sheet to the IRS if the revenue exceeds USD 250,000. Moreover, when borrowing a loan, the lender might ask the business to show its balance sheet.
Therefore, it becomes important to prepare a balance sheet for your small business. However, before we see the template for a balance sheet, let us go through the key components of it.
Key Components of a Balance Sheet
A balance sheet has three critical components – assets, liabilities, and shareholders equity. Let us look at these components separately and understand their role in the balance sheet.
1. Assets
Assets are anything valuable that a business owns or has a unique right over. The asset must be capable of generating benefits for the business in the future.
Thus, the asset can be sold and collected to flow the cash into the business or prevent cash from flowing out. An example of the assets that prevent cash from flowing out of the business is prepaid casualty insurance.
The capital, property such as business land, and employees are an example of assets. Now, the assets can be categorized as tangible or intangible, as well as current assets and long-term assets.
The current assets are the liquid able type of assets, such as cash and cash equivalents. Marketable securities, accounts receivables, inventory items, and prepaid expenses are current assets.
However, long-term assets include securities that cannot be liquidated in a year, fixed assets, and intangible assets.
2. Liabilities
An asset is essentially opposite in nature to the liabilities. The liabilities are what a company owes to an individual, group, or government.
For example, the company might owe rent or bonds issued to creditors, which will be considered a liability. There are two types of liabilities – current liabilities and long-term liabilities.
Current liabilities are due within one year, while long-term liabilities have longer tenure. However, the portion of the long-term liabilities due in a year is still considered a current liability.
Some common examples of liabilities are unearned premiums issued to customers and prepayments made to the company. Long-term debts, deferred tax liability, and pension fund liability to employees come under the long-term liabilities.
3. Shareholder Equity
Shareholder equity is the money the business owes to the shareholders. The shareholders can be the business owners, co-owners, or someone else.
Shareholder equity is actually the net asset of the company. It is the net asset of the company after subtracting its liabilities.
Shareholder Equity = Assets – Liabilities
However, shareholder equity might not be applicable to many kinds of businesses.
Example of a Balance Sheet
An example of a balance sheet will help you create your own balance sheet or search for a suitable template.
A typical balance sheet for a small business might look like this.
What is the Difference Between a Balance Sheet and an Income Statement?
The balance sheet and income statement serve different purposes in the financial analysis of a business.
The balance sheet lists the assets, liabilities, and shareholder equity. The income statement contains the revenues, expenses, and overall profit or losses for a business over a period of time. We have seen the key components of a balance sheet. Here are the key components of an income statement:
- Sales
- Cost of Goods Sold
- Gross Profit/Loss
- General and Administrative Expenses
- Earnings Before Tax
- Net Income
The purpose of the income statement is to calculate and show the net profit for the business. The balance sheet covers what the business owns and what it owes. It is an overview of the business’s total worth.
Importance of a Balance Sheet for a Business
Your balance sheet gives you, the lender, or authorities a good idea of how wealthy your business is. Here are different ways a business can utilize the balance sheet to aid the performance of the business.
1. Recognize the Dangers
The balance sheet can be used to help the company management recognize the dangers of going bankrupt. If the ratio of business assets to liabilities is less than 1, the business doesn’t have sound financial health. This might mean that the company is in danger of going bankrupt. Also, the short-term assets should cover the short-term liabilities, which means the ratio should be more than 1.
2. Demonstrate the Financial Health
A balance sheet might be required to demonstrate your financial health to lenders, creditors, or potential investors. When you borrow a business loan, your business might be required to prove its worth. This is also the case when the company is in talks with creditors and potential investors for fundraising or investments.
3. Evaluate the Business Worth for Investors or Buyers
It is complex to evaluate the total worth and net value of the company. A balance sheet is the simplest document that presents an overview of the net worth of the company. It is important when you want to share the value of the company with the investors or buyers.
4. Filing It to the Tax Authorities
Balance sheet has significant importance in and helps to prepare and file taxes. Often, you are required to file a balance sheet along with the income tax returns. For example, a C corporation must file the balance sheet along with the taxes.
3 Tips Create a Balance Sheet
Given the importance of a balance sheet, a small business owner or client accountant must know how to create it. Here are general tips for creating a balance sheet for small businesses.
1. Utilize a Software
The best method is to use the resources at your disposal to generate the balance sheet. If you use accounting software, you can generate the balance sheet directly from the software. All you need to do is accurately input the data for the assets, liabilities, equity, etc.
2. Reach Out to an Accountant
If you know an accountant or can reach out to professional accounting and tax services, you can ask them to prepare your balance sheet. You can give them precise information on the company’s assets, liabilities, and equity, and they will prepare the balance sheet for you.
3. Use a Template
The last resort is doing it on your own. Search for the balance sheet templates online and pick the most suitable one for you. Use this template to draft a balance sheet for your business and ensure it is accurate.
Learning to Analyze a Balance Sheet For Small Business
After preparing the balance sheet comes the step of analyzing it. A business owner must know how to analyze the balance sheet at a quick glance. When you start with analyzing the balance sheet, approach it in these small steps.
Compare Assets vs. liabilities
A business must own more and owe less, and this is the fundamental principle of the business industry. Therefore, explore the assets and liabilities in the balance sheet and see where you can improve and make adjustments.
Financial Ratio
The balance sheet is very often used for ratio analysis of financial indicators to evaluate the company’s performance. This helps one to understand the company’s profitability, liquidity, and solvency.
Profitability
The simplest way to gauge the profitability is through the retained earnings. Look at the total retained earnings and negative retained earnings and determine the profitability of the company.
Liquidity
Liquidity means the available cash or cash equivalent that the company has in store to pay the expenses and liabilities. Therefore, divide the current assets by the current liabilities and generate the liquidity ratio. The liquidity ratio over 1 means the company has more current assets than current liabilities to pay the expenses.
Let Us Prepare the Balance Sheet for Small Business
The above guide shall help you to create a balance sheet for small business. A balance sheet is a crucial document that the company must have for analysis and other purposes. Therefore, you should only entrust the task of preparation of the balance sheet to an accounting professional.
We suggest you connect with our accountants, who will prepare the balance sheet for your business in no time. For other accounting and taxation services, consult our advisors or take our free trial. Dial a toll-free number +1(800) 580-5375 now and explore our top-class accounting and bookkeeping services.