What Is A Balance Sheet And Why Does It Matter?
Your company’s balance sheet is the statement of your business’ current assets, shareholders’ equity, and current liabilities over a specified period. This provides an overview of your accounts receivables, payables, and investments.
This statement provides financial analysts with key information about a business’s current standings. With the balance sheet definition in tow, continue reading to find out its essential components and why it’s important for your business’s health.
Components Of A Balance Sheet
A balance sheet statement generally covers assets, liabilities, and shareholders’ equity. Here’s what to include in a balance sheet.
On the sheet, your company’s assets are listed in the order of their liquidity. Assets that can be quickly converted to cash are listed before long-term liquidity assets.
Current assets: These are assets that have a high potential of quickly turning into cash. You can further categorize current assets depending on the ratio of their liquidity.
- Cash: Your most liquid asset, followed by market securities
- Accounts receivables: Refers to the money that’s owed to you
- Inventory: Your stock of finished products
- Prepaid expenses: These are valuables for which payment has already been made. These include expensive office equipment, business insurance, and so on
Long-term assets: These are assets that aren’t likely to get converted to cash within a year. In the balance sheet accounts, they can further be broken down into the following categories.
- Fixed assets: This includes assets that are bought for long term use. For example, these assets could be land, office buildings, heavy equipment, and so forth
- Long-term securities: Investments that’ll liquidate over several years
- Intangible assets: This includes copyrights and patents
After assets, your sheet lists the liabilities. These are the incumbent expenses of your business. This includes debts, overhead costs, recurring costs, one-time costs, and your accounts payables. Liabilities can also be qualified as current and long-term. Current liabilities include costs of utilities, labor, immediate debt repayment, and taxes. Long term liabilities include deferred loan payments, pension funds, and so forth.
This refers to the difference between your total assets and liabilities. Moreover, it includes any investments made by your business’s shareholders.
How To Balance A Balance Sheet
One prerequisite when creating this balance sheet sample is that it has to be balanced. You must divide your statement into two columns. The first column will list out your assets. The second column will state your liabilities and the shareholders' equity.
Your sheet is balanced once the total assets of your company equate the sum of liabilities and the shareholders’ equity. This formula is its baseline:
Assets = Liabilities + Shareholders Equity
Seeing a balance sheet example will further demonstrate how liabilities and assets are listed over a given period.
The Importance Of A Balance Sheet
These sheets give you valuable insight into different accounting aspects of your business. When combined with other financial statements, these become a useful resource for expense tracking. Here are a few examples of how this sheet can help you gauge your finances.
- Liquidity: When you compare your current assets with the liabilities, you’re immediately apprised of your company’s liquidity status. Knowing how much immediate cash is available will help you to create a buffer between current assets and current liabilities
- Gauge efficiency: Billing software can help you deduce accurate financial statements. Matching your sheet with other financial statements allows you to gauge the efficiency of your business. For example, you can better determine your business’s ability to generate return-on-investment
- Financial leverage: With the help of this statement, you can determine whether your business is over-leveraged or not. The more financial leverage your business undertakes, the greater the associated risks are
Four Main Types Of Financial Statements
Your balance sheet is only one in a series of four basic types of financial statements. Each of these lends unique and valuable insights into the dynamics of your business operations.
- Income statement: This is known as the most important financial statement because the statement is directed at specifying what’s most valuable to any business: the profits it generates. Your company’s income statement gives a quick overview of the profits and losses sustained by it over a given period
- Balance sheet: By now you must be familiar with the purpose of a balance sheet statement. This statement is considered the second most important. These sheets offer crucial insights on a company’s liquidity status and theoretical value
- Cash flow statement: The purpose of a cash flow statement is to detail how much cash is flowing in and out of a business during a given operational interval. With a positive cash flow, businesses gain the opportunity to attract investors. This is because investors value a business’s ability to pay off debt with excess cash
- Statement of retained earnings: These statements outline the changes in the shareholders’ equity during a given operational period. Changes in equity usually result from the reporting of profits and losses
By comparing your business’s liquidity with the liabilities, you’ll get a clear idea of the direction that your business is heading in.
Knowing what a balance sheet is and mastering all financial statements is your gateway to a successful enterprise.