Understanding a Balance Sheet (With Examples and Video)

  • Accracy
  • 26th Nov, 2023

Balance sheets can help you see the big picture: the net worth of your small business, how much money you have, and where it's kept. They're also essential for getting investors, securing a loan, or selling your business.

Understanding a Balance Sheet (With Examples and Video)
Accounting

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.

While income statements and cash flow statements show your business's activity over a period of time, a balance sheet gives a snapshot of your financials at a particular moment. It incorporates every journal entry since your company launched. Your balance sheet 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. Investors, business owners, and accountants can use this information to give a book value to the business, but it can be used for so much more.

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, a metric 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.

Further reading: How to Read a Balance Sheet

What goes on a balance sheet

At a high level, a balance sheet works the same way across all business types. They 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. Bank accounts and other cash accounts should come first followed by fixed assets or tangible assets like buildings or equipment with a useful life longer than a year. Even intangible assets like intellectual properties, trademarks, and copyrights should be included. Anything you expect to convert into cash within a year are 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 (or non-current 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, copyrights, 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

Next come your liabilities—your business's financial obligations and debts.

List your liabilities by their due date. Just like assets, you'll classify them as current liabilities (due within a year) and non-current liabilities (the due date is more than a year away). These are also known as short-term liabilities and long-term liabilities.

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
  • Credit card debt

And here are some non-current 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:

Table

Equity

Equity is money currently held by your company. This category is usually called "owner's equity" for sole proprietorships and "stockholders' equity" or "shareholders' equity" for corporations. It shows what belongs to the business owners and the book value of their investments (like common stock, preferred stock, or bonds).

Owners' equity includes:

  • Capital (the amount of money invested into the business by the owners)
  • Private or public stock
  • Retained earnings (all your revenue minus all your expenses and distributions since launch)

Equity can also drop when an owner draws money out of the company to pay themself, or when a corporation issues dividends to shareholders.

For Where's the Beef, let's say you invested $2,500 to launch the business last year, and another $2,500 this year. You've also 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:

LIABILITIES  
Accounts payable $150
Long-term debt $2,000
Total liabilities $2,150

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

We're ready to put everything into a standard template (you can download one here). Here's what a sample balance sheet looks like, in a proper balance sheet format:

Balance Sheet example

Nice. Your balance sheet is ready for action.

Great. Now what do I do with it?

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.

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.

Here's some metrics you can calculate using your balance sheet:

  • Debt-to-equity ratio (D/E ratio): Investors and shareholders are interested in the D/E ratio of a company to understand whether they raise money through investment or debt. A high D/E ratio shows a business relies heavily on loans and financing to raise money.
  • Working capital: This metric shows how much cash you would hold if you paid off all your debts. It signals to investors and lenders how capable you are to pay down your current liabilities.
  • Return on Assets: A formula for calculating how much net income is being earned relative to the assets owned. The more income earned relative to the amount of assets, the higher performing a business is considered to be.
 
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