As a small business owner, you have to stay on top of your finances every day. Sometimes, though, you want to take a snapshot of your company’s financial situation to understand exactly where you stand. A balance sheet is a picture of your 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.
Just What Is a Balance Sheet?
As the term implies, a balance sheet is a two-column statement of items that are the same. Both columns need to 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. The equation is simply:
- Owner’s Equity = Assets – Liabilities
Assets on the Balance Sheet
Assets include all items of cash and property held by your company. Usually, assets on the balance sheet are divided into two categories: current assets and noncurrent assets.
Current assets include:
- Cash, such as money in petty cash, deposits in checking and savings accounts, and any short-term investments that can readily be converted into cash.
- Marketable securities, including stocks, bonds, and other securities held for investment that are readily tradable.
- Accounts receivable (A/R) owed to your company by a customer or client that are expected to be paid within a year.
- Inventory, including 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, such as amounts for insurance coverage or other expenses that you expect to use or apply within one year.
Noncurrent assets include:
- Property, such as equipment and machinery, buildings and land, and furniture and fixtures.
- Intangible property, including copyrights, patents, and trademarks, as well as goodwill.
Liabilities on the Balance Sheet
Liabilities are debts or other obligations of the company that could have a negative effect on its 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:
- Accounts payable (AP) owed to suppliers and vendors for goods or services bought by the company.
- Accrued expenses incurred by your business without any invoice, such as wages, employee benefits (e.g. medical insurance, retirement plan contributions), and federal and provincial taxes
- Short-term borrowing, which includes company credit card bills and lines of credit.
- Unearned revenue from a product or service that has yet to be delivered or performed.
Long-term (fixed) liabilities include:
- Mortgages taken out to buy or build the company’s facilities (e.g. buildings, factories, etc.)
- Other loans for company vehicles, equipment purchases, and loans from shareholders.
- Bonds 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 your owner’s interest in the company. Subtracting the liabilities from the assets gives you the value of your equity
Owner’s equity breaks down into three basic categories:
- Capital that owners initially put into the business
- Additional paid-in capital that owners add to the business after the initial funding
- Retained revenue, or the earnings of the business that are kept in the company rather than being distributed to the individual owners
If you have positive equity, your assets exceed your liabilities. If your 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 you total and add to the owner’s equity. When the sum of liabilities and owner’s equity is totaled, the amount should be equal to the total amount of assets in the left column.
For example, say you run an ice cream shop. Your current assets might include $2,000 cash in the bank plus $500 in accounts receivable for an upcoming catering gig and $3,000 worth of inventory (ice cream, cones, spoons, and the like). Your fixed assets might include tables and chairs worth $500, and $7,000 in freezers, and $1,000 for your computers and point-of-sale equipment. The numbers on the asset side of your balance sheet look like this:
- ($2,000 + 500 + 3,000) + ($500 + 7,000 + 1,000) = $14,000
The right side of your balance sheet shows your liabilities. Your current liabilities might include $1,000 in accounts payable for more ice cream and supplies, $500 for sales tax, and $1,500 owed in salary and wages to your employees. Your long-term liabilities might include $4,000 outstanding for a business loan you took to start the company. The numbers on the liabilities side of your balance sheet look like this:
- ($1,000 + 500 + 1,500) + 4,000 = $7,000
When you subtract your liabilities from your assets ($14,000 – 7,000), the remainder ($7,000) is your owner’s equity.
If you use an 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 already entered into the system.
Your balance sheet is an important financial statement (along with your income statement and cash flow statement) that helps you monitor your company’s health. You also need a balance sheet when you apply for commercial financing. If you have any concerns about creating or understanding your balance sheet, work with a knowledgeable financial specialist. 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.