The Ultimate Guide to the Balance Sheet
The Balance Sheet is a critical financial statement for a Small Business and deserves your time and attention as a Small Business Owner. Think of the Balance Sheet as a summary of a company’s financial activity.
The Balance Sheet includes three distinct components – Assets, Liabilities, and Equity. Each of these components, when combined, provide a high-level overview of the overall health of the company.
This critical financial statement can quickly provide anyone reviewing it with the financial stability of the organization. Each of the three components offers a different vantage point of a company’s economic health.
Balance Sheet Overview
The Balance Sheet is a snapshot in time of the overall financial position of a company. The distinction of the Balance Sheet being a snapshot is very important. Unlike the Income Statement, which covers a period, the Balance Sheet references a set point in time. So in other words, if I look at a Balance Sheet run on December 31st, 2016, then the Balance Sheet references financial information as of that date.
Think of it as taking a picture of the financial summary of your business at a specific moment in time. That moment in time exists only that moment. The Balance Sheet continually changes, keeping an economic score of your business. This snapshot distinction makes the Balance Sheet the unique among the three financial statements.
Another critical feature of the Balance Sheet is that at its core lies a mathematical equation. This equation is what causes the Balance Sheet to balance – hence its name. The formula is made up of the three main core components of the Balance Sheet – Assets, Liabilities, and Equity. If the Assets of your company do not equal total of the Liabilities plus Equity, then there is an issue with the way certain transactions are being accounted correctly.
The Balance Sheet equation is as follows:
Assets = Liabilities + Equity
The Assets of your Small Business must be equal to the Liabilities plus Equity, or the Balance Sheet will not balance. It is critical that the Balance Sheet is in balance to provide an accurate picture of the financial health of the business.
A Balance Sheet that does not balance is just not a Balance Sheet. It is instead a misrepresentation of the economic state of the small business.
The Three Components
Now that we have a basic understanding of the Balance Sheet we will take a look at it’s three main components in more detail.
Assets are items that provide a future financial or economic benefit to the organization. Think of Assets as those items that add value to the overall business. So in other words, a specific piece of equipment used to manufacture the products you sell is an Asset. That equipment adds value to the company.
The assets of a Small Business are further divided into Current and Long-Term Assets.
Current Assets = Assets that can be converted into cash in less than one year.
Example: Cash or Short-term investments
Long-Term Assets = Assets that will be used by the organization for more than one year.
Example: Plant, Property, and Equipment
Below is an example of the Assets section of a Small Business Balance Sheet:
Liabilities are items that have a future financial or economic reduction. These are items that will detract, or take away from the value of the business. In other words, the loan that you took out to fun your Working Capital needs will eventually be paid back which removes money from the business. So this loan, while needed, will extract value from the company.
The liabilities of a company are further divided into Current and Long-Term Liabilities.
Current Liabilities= Liabilities that have a due date of less than one year from now.
Example: Accounts Payable
Long-Term Liabilities = Liabilities that have a due date more than one year from now.
Example: Long-Term Debt
Below is an example of the Liabilities section of a Small Business Balance Sheet:
Equity is the Shareholders Interest or claim of ownership in the business. In essence, this is the value of the company when you remove the Liabilities from the Assets of the company. By adjusting the Balance Sheet equation, we can see this mathematically.
Equity = Assets – Liabilities
Some of the more common items in the Equity section of the Balance Sheet include Common Stock and Retained Earnings.
Common Stock = An ownership stake in a company usually represented through the ownership of shares or stock.
Retained Earnings = A portion of the businesses Net Income that rather than being distributed to owners usually in the form of dividends, is retained or kept in the company and reinvested.
Below is an example of the Equity section of a Small Business Balance Sheet:
So those are the three components that make up the Balance Sheet.
The Balance Sheet is the linchpin on which all other financial statements connect. It represents the real economic reality of the business defined regarding its assets, liabilities, and equity. Think of the Balance Sheet as the financial scorecard of a company. The higher the score that the Assets and Equity side and the lower the score that the liabilities have the better the economic health of the business.
- The Balance Sheet is a snapshot in time of the overall financial position of the business.
- At the core of the Balance Sheet is an equation which states that Assets = Liabilities + Equity
- A Balance Sheet must balance