The balance sheet is one of four basic financial statements. It’s used for internal and external reporting purposes. Of the four statements, the balance sheet is the only one that refers to a single point in time rather than a period of time. This is a summary of your company’s financial position. As a small business owner, you should regularly analyze your assets, liabilities and available capital. Your balance sheet can help you secure a loan and give you valuable insight into your operation and future growth potential.
The balance sheet is displayed in a vertical format and broken down into three main sections: assets, liabilities and equity. Each section should include a total. Per the fundamental accounting equation, your assets should equal the sum of your liabilities and equity.
- Title: This is only necessary for external reporting, but it’s a good habit to get into. Include your company name, the exact day and year, and the title “Balance Sheet.”
- Current Assets: The balance sheet begins with current assets. Examples include cash, receivables, inventory, prepaid expenses and other highly liquid accounts.
- Non-Current Assets: These are also called long-term assets. This section includes equipment, land and buildings. In general, long-term accounts are those that stay on your books for more than one year. In other words, they provide a benefit beyond just one accounting period. Some assets, such as equipment and vehicles, may include a subcategory for depreciation. This is known as a contra-asset account. It simply serves as a subtraction tool to show you how much your assets have depreciated over time. The rate depends on which method you use: straight line, double-declining, sum-of-years or units of production.
- Current Liabilities: This section is structured much like your assets. Current liabilities are listed first and include debts that are meant to be settled in one year or less. Examples include accounts payable, taxes, accrued payroll expense and unearned revenue.
- Long-Term Liabilities: These are debts with maturities over one year, such as notes payable, bonds payable, mortgage payable and capital leases.
- Owner’s Equity: For most small businesses and unincorporated companies, this section is fairly basic. It details your retained earnings and the exact amount you have invested in the business. For corporations, this section shows the amount of common and preferred stock that has been declared to shareholders.
Reading Your Balance Sheet
Essentially, you pay for your assets by taking on liability. If you are incorporated, you can also issue stock. Any excess over shareholder distributions is left as retained earnings. By dividing your total debt by your total equity, you can see how leveraged you are. In other words, how much of your assets are you financing with debt? In general, the more debt you carry, the greater risk you carry.
The balance sheet also measures your liquidity. This is the reason you categorize accounts. By dividing your total current assets by your total current liabilities, you will get an acid-test ratio, which measures your ability to turn assets into cash and how quickly you can pay off your expenses.
It’s important to understand how your various accounts are recorded. Furthermore, the Securities and Exchange Commission (SEC) and Generally Accepted Accounting Principles (GAAP) enforce specific practices for recording financial information. In general, all assets are recorded at historical cost. Your building account, for instance, may or may not reflect it’s true market value. Furthermore, companies cannot use the balance sheet to record non-monetary assets like customer loyalty and brand names.
Using Your Balance Sheet
Unlike your income statement, which details your spending and earning over a certain period, the balance sheet can show you your financial position at any point in time. This is your key tool if you decide to apply for a loan or if you want to attract investors.
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