What Is a Balance Sheet? A Small Business Guide with Definitions and Examples
A balance sheet is one of the four basic financial statements in business accounting. Balance sheets give a statement of a business’s assets, liabilities and shareholders equity at a specific point in time. They offer a snapshot of what your business owns and what it owes as well as the amount invested by its owners, reported on a single day. A balance sheet tells you a business’s worth at a given time, so you can better understand its financial position.
What is a balance sheet? These topics will help you understand what’s included on a balance sheet and what it tells you about the financial position of your small business:
What Items Are on a Balance Sheet?
A balance sheet reports the assets, liabilities and shareholders equity of your business at a given point in time. The items reported on the balance sheet correspond to the accounts outlined on your chart of accounts. A balance sheet is made up of the following elements:
The assets section of the balance sheet breaks down what your business owns of value that can be converted into cash. Your balance sheet will list your assets in order of liquidity; that is, it reports assets in order of how easily they can be converted to cash. There are two main categories of assets included on your balance sheet:
- Current Assets: Current assets can easily be converted to cash within a year or less. Current assets are further broken down on the balance sheet into these accounts:
- Cash and cash equivalents: These are your most liquid assets, including currency, checks and money stored in your business’s checking and savings accounts
- Marketable securities: Investments that you can sell within a year
- Accounts receivable: Money that your clients owe you for your services that will be paid in the short term
- Inventory: For businesses that sell goods, inventory includes finished products and raw materials
- Prepaid expenses: Things of value that you’ve already paid for, like your office rent or your business insurance
- Long-Term Assets: Long-term assets won’t be converted to cash within a year. They can be further broken down into:
- Fixed assets: Includes property, buildings, machinery and equipment like computers
- Long-term securities: Investments that can’t be sold within one year
- Intangible assets: Assets that aren’t physical objects, such as copyrights, franchise agreements and patents
The next section of a balance sheet lists a company’s liabilities. Your liabilities are the money that you owe to others, including your recurring expenses, loan repayments and other forms of debt. Liabilities are further broken down into current and long-term liabilities.
Current liabilities include rent, utilities, taxes, current payments toward long-term debts, interest payments and payroll.
Long-term liabilities include long-term loans, deferred income taxes and pension fund liabilities.
Shareholders equity refers to the amount of money generated by a business, the amount of money put into the business by its owners (or shareholders) and any donated capital. Shareholders equity is your net assets. On your balance sheet it’s calculated using this formula:
Stakeholders Equity = Total Assets – Total Liabilities
Balancing a Balance Sheet
When creating a balance sheet for your business it’s important to understand that, as the name suggests, your balance sheet must always be balanced. A balance sheet is divided into two sections, with one side representing your business’s assets and the other showing its liabilities and shareholders equity.
The total value of your assets must be equal to the combined value of your liabilities and equity. When that’s the case, your document is said to be in balance. This idea is represented by the foundational formula of balance sheets:
Assets = Liabilities + Shareholder Equity
Why Is a Balance Sheet Important?
A balance sheet is an important financial statement that gives a snapshot of the financial health of your business at a point in time. You can also look at your balance sheet in conjunction with your other financial statements to better understand the relationships between different accounts. A balance sheet is important because it provides the following insights about your business:
By comparing your business’s current assets to its current liabilities, you’ll get a clear picture of the liquidity of your company, or how much cash you have readily available. You always want to have a buffer between your current assets and liabilities to cover your short-term financial obligations, with assets always greater than liabilities.
By comparing your income statement to your balance sheet, you can measure how efficiently your business uses its assets. For example, you can get an idea of how well your company is able to use its assets to generate revenue.
Your balance sheet can help you understand how much leverage your business has, which tell you how much financial risk you face. To judge leverage, you can compare the debts to the equity listed on your balance sheet.
Balance Sheet Example
This example of a completed balance sheet from Accounting Play can help you better understand what information is reported on a balance sheet, how it’s laid out and how the two sides of the balance sheet balance each other out.
What Are the Four Basic Financial Statements?
The balance sheet is one element in a series of four basic financial statements that together give an overview of your business’s financial performance. These are the four basic financial statements and how they’re used to evaluate a business’s finances:
Income Statement: A business’s income statement, also called a profit and loss statement, reports the revenues, expenses and profits or losses generated during a specific reporting period. It’s considered to be the most important of the four financial statements because it shows the profits a business is generating.
Balance Sheet: A balance sheet lists a company’s assets, liabilities and shareholders equity at a specific point in time. It’s usually thought of as the second most important financial statement, since it shows the liquidity and the theoretical value of the business.
Cash Flow Statement: The cash flow statement shows the money flowing into and out of a business during a specific reporting period. The cash flow statement is important to lenders and investors to determine whether a business has access to the cash needed to pay off its debts.
Statement of Retained Earnings: The statement of retained earnings shows the changes in equity within a business for a specific reporting period. The statement is typically made up of dividend payments, the sale or repurchase of stock and changes resulting from the reporting of profits or losses.