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If you’re looking to understand the basics of accounting, it starts with your business’s balance sheet. An SBA study found that 50% of businesses don’t make it more than 5 years. To avoid that same fate, it’s important to take an objective look at your business and understand the basics of your business accounting. You need to know how much money you have, how much you owe, and what the business is worth. Consequently, a business balance sheet is one of your most important financial statements. The balance sheet, along with the income statement and statement of cash flow, helps business owners and investors gauge the health of a business. Because of this, it’s worth taking the time to learn how to read and use a classified balance sheet for your own business. In this article, we’ll answer the question, “What is a balance sheet?” using a balance sheet example and template as our guide.
What is a Balance Sheet?
A balance sheet is one of your business’s most important financial statements. It tells you what a business is worth. In fact, a balance sheet offers a snapshot of the business’s overall health at the time of the report. Analysts use this tool to peek at and analyze the value of the business today. However, it should be noted that a balance sheet isn’t useful for projection purposes.
When putting together a balance sheet, you will need three main components:
- Assets: What your business owns.
- Liabilities: What your business owes (i.e., your business’s debts).
- Equity: The value of your business (how much the business owns minus any debts) from a shareholder’s perspective. This is also known as the owner’s equity.
These components are important because they give insight into the relative health of your business. When used properly, there is a lot you can learn about your business by analyzing its balance sheet. Using a basic equation, the balance sheet is split into two equal columns. These columns must always be in balance.
The Balance Sheet Equation: Assets = Liabilities + Equity
Note: We’ll explore the three individual elements in a bit more detail later in this article.
The Purpose of a Balance Sheet
As we touched on, the balance sheet is not useful as a projection tool on its own. So you may be wondering, what is the purpose of a balance sheet? Let’s discuss.
People who commonly use a balance sheet include:
- Potential investors who are looking into the health and value of a company to help them decide whether or not to invest in it.
- Business owners who are looking to strategize or decide what their next move should be. Examples could include things like whether they should take out additional debt, look for an investor, or sell off an asset to reduce debt.
- Employees to understand whether the business is succeeding or failing. This insight will let internal stakeholders pivot toward something new or make changes to policies that benefit the overall value and collective goals of the organization.
The bottom line is that a classified balance sheet is useful both internally and externally as a means of looking objectively at the business and making informed decisions to benefit the organization. If you’re looking for a projection tool, consider cash flow projection.
The Elements of a Balance Sheet
There are three main elements to the classified balance sheet that require consideration. Once we’ve explored the individual elements, you will be able to create a useful balance sheet template for your business.
Assets
The first category of the balance sheet is assets. This category can be split into two main groups: Current assets, and fixed (or non-current) assets.
Current Assets are anything you own that can quickly be converted to cash (i.e., liquid assets). “Quickly” usually refers to 12 months or less. Some examples of things that are current assets are cash, inventory or stock, and accounts receivable. These are technically considered cash on hand.
Fixed Assets, on the other hand, are less liquid assets. They’re things that can’t or won’t easily convert to cash (i.e., something you’ll own for 12 months or more). Fixed assets include things like real estate, vehicles, or major equipment.
There is a third category of assets that can’t easily be quantified. This category is intangible assets which include things such as your brand name, trademarks, and other intellectual property. Due to their subjective valuation, they are not included on a balance sheet.
Liabilities
The next category of the balance sheet is liabilities. Liabilities are most commonly referred to as debt. Similar to the assets category, there are distinctions on the balance sheet for current and long-term liabilities.
A current liability is anything you’ll need to pay within 12 months. A long-term liability is something that will take more than 12 months to pay. For example, a business’s current liabilities often include things like small business purchases made on a credit card. A business’s long-term liabilities, on the other hand, often include long-term equipment leases or a mortgage on the corporate building.
Equity
The final category you’ll find on a balance sheet is equity. This is where you’ll account for things like the initial investment into starting the company and any earnings you have reinvested into the business.
The Balance Sheet Equation
When you compile the three components together, you’ll get a classified balance sheet. As we briefly touched on, the balance sheet equation is a simple one:
The Balance Sheet Equation: Assets = Liabilities + Equity
The balance sheet equation is in reference to the format of the sheet. On the left-hand side of the sheet, you’ll record your assets. On the right-hand side of the sheet, you’ll tally the outstanding liabilities and owner’s equity. The two sides should always be equal (i.e., in balance).
A Helpful Balance Sheet Example
As a concept, the balance sheet is more difficult to explain than it needs to be. To aid with the explanation, see the chart below for a helpful balance sheet template:
Assets Liabilities + Equity
Current Assets Current Liabilities
Cash $10,000 Accounts payable $15,000
Accounts receivable $25,000
Inventory $25,000
Total Current Assets $60,000 Total Current Liabilities $15,000
Fixed Assets Long-term Liabilities
Equipment $100,000 Loan payable $15,000
Total Fixed Assets $100,000 Total Long term liabilities $15,000
Owner’s Equity $130,000
Total assets $160,000 Liabilities + Owner’s Equity $160,000
This balance sheet example can help you format and understand your own better.
Utilizing Financial Statements
Now you can use a classified balance sheet to your advantage. While the balance sheet example above is likely much simpler than the balance sheet template you’d put together for your business, it’s a handy reference tool you can save for whenever you need a refresher.
Utilizing financial statements is a skill worth mastering. Financial statements are extremely useful tools both inside and outside of the organization. Using a classified balance sheet properly will help your business stand the test of time.
