Balance sheets can help you see the big picture: the net worth of your company, how much money you have, and where it’s kept. They’re also essential for getting investors, securing a loan, or selling your business.
So you definitely need to know your way around one. That’s where this guide comes in. We’ll walk you through balance sheets, one step at a time.
What is a balance sheet?
The balance sheet is one of the three main financial statements, along with the income statement and cash flow statement.
A balance sheet gives a snapshot of your financials at a particular moment, incorporating every journal entry since your company launched. It shows what your business owns (assets), what it owes (liabilities), and what money is left over for the owners (owner’s equity).
Because it summarizes a business’s finances, the balance sheet is also sometimes called the statement of financial position. Companies usually prepare one at the end of a reporting period, such as a month, quarter, or year.
The purpose of a balance sheet
Because the balance sheet reflects every transaction since your company started, it reveals your business’s overall financial health. At a glance, you’ll know exactly how much money you’ve put in, or how much debt you’ve accumulated. Or you might compare current assets to current liabilities to make sure you’re able to meet upcoming payments.
The information in your company’s balance sheet can help you calculate key financial ratios, such as the “debt to equity” ratio, which shows the ability of a business to pay for its debts with equity (should the need arise!). Even more immediately applicable is the current ratio: current assets / current liabilities. This will tell you whether you have the ability to pay all your debts in the next 12 months.
You can also compare your latest balance sheet to previous ones to examine how your finances have changed over time. You’ll be able to see just how far you’ve come since day one.
What goes on a balance sheet
All balance sheets are organized into three categories: assets, liabilities, and owner’s equity.
Assets
Let’s start with assets—the things your business owns that have a dollar value.
List your assets in order of liquidity, or how easily they can be turned into cash, sold, or consumed. Anything you expect to convert into cash within a year is called current assets.
Current assets include:
- Money in a checking account
- Money in transit (money being transferred from another account)
- Accounts receivable (money owed to you by customers)
- Short-term investments
- Inventory
- Prepaid expenses
- Cash equivalents (currency, stocks, and bonds)
Long-term assets, on the other hand, are things you don’t plan to convert to cash within a year.
Long-term assets include:
- Buildings and land
- Machinery and equipment (less accumulated depreciation)
- Intangible assets like patents, trademarks, and goodwill (you would list the market value of what fair price a buyer might purchase these for)
- Long-term investments
Let’s say you own a vegan catering business called “Where’s the Beef”. As of December 31, your company assets are money in a checking account, an unpaid invoice for a wedding you just catered, and cookware, dishes, and utensils worth $900. Here’s how you’d list your assets on your balance sheet:
| ASSETS | |
|---|---|
| Bank account | $2,050 |
| Accounts receivable | $6,100 |
| Equipment | $900 |
| Total assets | $9,050 |
Liabilities
Then there are your liabilities, or what your company owes to others.
List your obligations in order of their due date. You’ll categorize them as current (due within a year) or long-term, much like assets (the due date is more than a year away).
Your current liabilities might include:
- Accounts payable (what you owe suppliers for items you bought on credit)
- Wages you owe to employees for hours they’ve already worked
- Loans that you have to pay back within a year
- Taxes owed
And here are some (non-current) long-term liabilities:
- Loans that you don’t have to pay back within a year
- Bonds your company has issued
Returning to our catering example, let’s say you haven’t yet paid the latest invoice from your tofu supplier. You also have a business loan, which isn’t due for another 18 months.
Here are Where’s the Beef’s liabilities:
| LIABILITIES | |
|---|---|
| Accounts payable | $150 |
| Long-term debt | $2,000 |
| Total liabilities | $2,150 |
Equity
Equity is money currently held by your company. (This category is usually called “owner’s equity” for sole proprietorships and “stockholders’ equity” for corporations.) It shows what belongs to the business owners.
Owners’ equity includes:
- Capital (money invested into the business by the owners)
- Private or public stock
- Retained earnings (all your revenue minus all your expenses since launch)
When an owner withdraws money from the firm to pay themselves, or when a corporation pays dividends to shareholders, equity might fall.
For Where’s the Beef, let’s say you invested $2,500 to launch the business in 2016, and another $2,500 a year later. Since then, you’ve taken $9,000 out of the business to pay yourself and you’ve left some profit in the bank.
Here’s a summary of Where’s the Beef’s equity:
| OWNER’S EQUITY | |
|---|---|
| Capital | $5,000 |
| Retained earnings | $10,900 |
| Drawing | -$9,000 |
| Total equity | $6,900 |
The balance sheet equation
This accounting equation is the key to the balance sheet:
Assets = Liabilities + Owner’s Equity
Assets go on one side, liabilities plus equity go on the other. The two sides must balance—hence the name “balance sheet.”
It makes sense: you pay for your company’s assets by either borrowing money (i.e. increasing your liabilities) or getting money from the owners (equity).
A sample balance sheet
