What is a Balance Sheet?
The balance sheet is a simple but powerful financial tool that all small business owners should understand. A balance sheet tells you at a glance whether your business has more assets than liabilities, and vice versa. This information is important because it can help you make informed decisions about how to grow your business.
Knowing the difference between assets and liabilities is crucial to understanding your balance sheet.
Assets are anything that you own and can use to pay your debts.
Assets are any tangible or intangible items of value that your firm owns. In the sheet, assets are listed in chronological order (top to bottom) based on liquidity or their ability and ease to be converted into cash. They are separated into current and fixed assets. The general order of assets that can be seen on the sheet are:
- Cash – including hard currency, short-term deposit, and Treasury bill.
- Marketable securities
- Accounts receivables – any cash owed by customers to a company for their services or goods.
- Inventory – refers to a company’s finished products that are currently on-hand and for sale.
- Prepaid expenses
- Long-term investments – items that cannot be converted into cash the following year.
- Fixed assets – pieces of equipment, machinery, or land that a firm uses to sustain its operations.
- Intangible assets – include copyrights, patents, and franchise agreements. These assets are only included in the sheet if they have a definite lifespan and an identifiable market value.
Liabilities, on the other hand, are anything that you owe.
The most common type of liability for small businesses is a loan.
Liabilities represent a firm’s payment obligations to outside parties. It is categorised into two: current liabilities, which refers to money owed that is due within one year, and long-term liabilities are amounts with more than one year to pay.
Examples of current liabilities are:
- Bank indebtedness
- Interest and wages payable
- Customer prepayments
- Dividends payable
- Earned and unearned premiums
- Accounts payable
While long-term liabilities include long-term debt, pension fund liability, and deferred tax liability.
Equity & Retained Earnings
Equity is the third major category on a balance sheet.
Equity represents the ownership interest that the business owner has in the company. Equity can be positive or negative; if it's negative, that means the business owes more money than it's worth.
The final part of the balance sheet is called "retained earnings."
Retained earnings represent the profits that the business has earned over time, minus any dividends that have been paid out to shareholders.
The balance sheet, together with income and cash flow statements, are the foundations of a firm’s financial statement.
Also known as the “statement of financial position”, a balance sheet provides a “snapshot” of a company’s finances as at a certain date (the date shown on the report)
Typically a Balance Sheet will be shown with comparative information eg the previous month or previous year.
A balance sheet is a vital financial tool for all small business owners. It provides a snapshot of your company's financial health, including its assets, liabilities, and equity. Understanding your balance sheet can help you make informed decisions about how to grow your business.