A balance sheet is a financial statement that summarizes the financial status of your business for a particular time. Simply, a balance sheet indicates your business’ assets, shareholder equity, and liabilities. Every transaction you make in your business affects the balance sheet in one way or another. Understanding how to read and decipher this financial document is essential for leading your business toward greater success. Below is a guide on how to make sense of your balance sheet.
Contents of a Balance Sheet
A balance sheet is typically organized using the equation: assets = liabilities + owners’ equity. Using this formula, the information on this document must always agree. When the data is correct, your internal teams or an interested external party will be able to ascertain the health of your business. A balance sheet contains three main categories of data:
Assets are anything that is owned under your business’ name. The two types of assets are current assets and noncurrent assets. Current assets include cash and other things you can easily turn into cash within one year, such as accounts receivable, bank accounts, and petty cash. On the other hand, noncurrent assets are things that cannot be easily turned into cash within one year. Examples of noncurrent assets are buildings, vehicles, heavy machinery, and land. Intangible assets such as patents and trademarks are also categorized under noncurrent assets.
Liabilities are the opposite of assets. They are amounts that your business owes others. The two main types of liabilities are current liabilities and long-term liabilities. Current liabilities are amounts your business is likely to pay within one year, such as debts to vendors, sales tax, and credit card balances. Long-term liabilities are debts that will typically take more than one year to pay off, such as car loans, mortgages, and long-term leases.
Equity is the balance between liabilities and assets. It is the amount the business owes to you after all liabilities have been accounted for. Equity mainly consists of the following:
- Your contribution to the business
- Capital and preferred stock
- Retained earnings
- Annual net income
Once you have paid off all your business’ liabilities with the assets, what’s remaining of the business is the equity. If the business’ liabilities are more than the assets, then the equity will be negative. But, if the assets are more than the liability, the equity will be positive.
Gain More Insight With a Balance Sheet
The best time to begin your balance sheet is when your business is still new. You first list all the bank accounts you assign to your business as assets and subtract any business loans you have taken to get the equity. This creates a clear and consistent template for you to continue documenting your finances.
Accurate bookkeeping and accounting are necessary to the success of any business, regardless of age or size, and diligent financial documentation plays a large part in this. A proper balance sheet will help you, your accounting team, and your potential investors analyze your company’s financial health. This analysis helps you achieve your goals and make informed decisions regarding the future direction of your business. For more information about balance sheets, contact a trusted accountant to obtain the information you need for long-term success.