A balance sheet is a picture of a company’s net worth at a given time, such as the end of the year. It reflects the company’s assets, liabilities and owner’s equity. It’s important to create and review this financial statement to track the growth (or contraction) of your business.
As the term implies, a balance sheet is a two-column statement of items that are the same: both columns should balance each other out. The first column is a list of assets
Assets = Liabilities + Owner’s Equity
The balance sheet helps you see how much an investment in your business is worth. To do this, simply express the equation as:
Owner’s Equity = Assets – Liabilities
Assets on the Balance Sheet
“Assets” include all items of cash and property held by the company. Usually, assets on the balance sheet are divided into two categories: current assets and noncurrent assets.
Current assets include:
- Cash: Money in petty cash, deposits in checking and savings accounts, and any short-term investment that can readily be converted into cash.
- Marketable securities: Stocks, bonds and other securities held for investment that are readily tradable.
- Accounts receivable (A/R): Money owed to the company by a customer or client that is expected to be paid within a year.
- Inventory: Raw materials, works in progress and finished goods produced or acquired for sale to customers in the normal course of business. Businesses may have an obsolescence reserve that reduces the inventory asset on the balance sheet.
- Pre-paid expenses: Amounts for insurance coverage or other expenses that are expected to be used or applied within one year.
Noncurrent assets include:
- Property: Equipment and machinery, buildings and land, furniture and fixtures.
- Intangible property: Copyrights, patents and trademarks, as well as goodwill.
Liabilities on the Balance Sheet
These are debts or other obligations of the company that have a negative effect on net worth. There are two basic categories of liabilities: current liabilities and long-term (fixed) liabilities.
Current liabilities, which are liabilities reasonably expected to come due within a year, include:
- Payables: Money owed to suppliers and vendors for goods or services bought by the company. This is also referred to as accounts payable (A/P).
- Accrued expenses: Expenses incurred by the business for which there is no invoice, such as wages, employee benefits (e.g. medical insurance, retirement plan contributions) and federal and state taxes
- Short-term borrowing: Company credit card bills, lines of credit, etc.
- Unearned revenue: Revenue from a product or service that has yet to be delivered or performed.
Long-term (fixed) liabilities include:
- Mortgages: Borrowing to buy or build the company’s facilities (e.g. buildings, factories, etc.)
- Other loans: Loans for company vehicles, equipment purchases and loans from shareholders.
- Bonds: Debt instruments issued by the company to raise capital (this type of liability is unusual for a small business).
Owner’s Equity on the Balance Sheet
This portion of the balance sheet represents the value of owners’ interest in the company. The value is the amount by which assets exceed liabilities.
Owner’s equity can be comprised of three basic categories:
- Capital that owners initially infused into the business.
- Additional paid-in capital that owners added to the business after the initial funding.
- Retained revenue, which is the earnings of the business that have not been distributed to owners but kept in the company.
Positive equity means that assets exceed liabilities. If equity is negative, there are more liabilities than assets, and the company is in trouble.
Creating a Balance Sheet
To create a balance sheet manually, use two columns for entries of the items discussed earlier. The left column is for listing your assets, with a total of assets at the end of the column. The right column is for listing liabilities, which are totaled and then added to the owners’ equity. When the sum of liabilities and owners’ equity are totaled, the amount should be equal to the total amount of assets in the left column.
As a practical matter, if you use a sound accounting system, such as QuickBooks, you can generate a balance sheet automatically. You don’t have to enter items into categories, since the software does this for you based on information you’ve already entered into the system.