The balance sheet shows business owners the big picture of their company’s net worth. Business owners often use it to secure investors, get loans, or sell the business.
There are three main financial statements used for business accounting: the profit and loss statement, the cash flow statement, and the balance sheet. Below, we walk you through how to read a balance sheet and what it tells you about your business.
What Is a Balance Sheet?
The balance sheet differs from the profit and loss and cash flow statements because it is a snapshot of the business’s financials at a point in time. The other two statements, on the other hand, show activity over a period of time.
A balance sheet lists your business’s assets (what it owns), liabilities (what it owes), and the amount left over for owners’ equity. Owners’ equity is the portion of assets the owner can claim as their own after subtracting all liabilities.
The balance sheet is usually prepared at the end of the company’s financial reporting period for the month, quarter, or year.
What Does the Balance Sheet Tell You About Your Business?
The balance sheet reflects all financial transactions since the business’s launch, showing how much money was put into it and how much debt it has accumulated to date. By examining the balance sheet, business owners, investors, and accountants can determine the book value of the business.
You can also use this data to find the debt-to-equity ratio (D/E ratio). This is a metric showing the business’s ability to pay its debts with its equity. The accounting equation for this is total debt divided by shareholder equity. Investors and shareholders watch the D/E ratio. This is because it indicates whether the company has raised money through its own investments or by taking on debt.
For instance, a high D/E ratio would show that the business relies heavily on loans and financing to raise money. A low D/E, on the other hand, indicates less debt. A new or growing business will often use debt to drive its growth. That’s why a higher debt-to-equity ratio is not necessarily bad, especially in a company’s early stages.
What Does the Balance Sheet Include?
The balance sheet has three categories: assets, liabilities, and owners’ equity. Below is a detailed explanation of each.
Assets
Assets are things the business owns that it can convert into cash within a year. They are listed on the balance sheet in order of liquidity, with current assets first, followed by long-term (or non-current) assets.
Current assets may include money in cash accounts, accounts receivable, short-term investments, inventory, prepaid expenses, and cash equivalents like stocks and bonds.
Long-term assets, also called fixed assets, are those you do not plan to convert into cash within a year. This includes real estate; equipment (less accumulated depreciation); long-term investments; and intangible assets like trademarks, patents, and copyrights. The balance sheet will list the fair market value a buyer might pay to purchase these.
Finally, net assets are the sum of everything the business owns (gross assets) minus the total cost of its debts (liabilities).
Liabilities
Liabilities are the business’s financial obligations and debts. These are listed in order of when each is due.
Just like assets, liabilities can be current or non-current. Current means payments are due within a year, while non-current liabilities have a due date more than a year away. These can also be called short-term liabilities and long-term liabilities.
Current and short-term liabilities can include accounts payable, employee wages owed for work already completed, loans that must be paid back within a year, taxes owed, and credit card debt.
Examples of long-term liabilities can be long-term debt, bonds the company issues, or long-term lease obligations.
Equity
Equity is money the business currently has, which on the balance sheet is called “owners’ equity.” For corporations, it’s instead referred to as “stockholders’ equity” or “shareholders’ equity.” This is what belongs to the owners and the book value of their investments, such as common stock, preferred stock, or bonds.
Owners’ equity includes capital, which is the amount they invested into the business using their own money. It can also include private or public stock and retained earnings. The accounting equation for retained earnings is total revenue minus all expenses and distributions since the business’s launch.
A company’s equity decreases when an owner takes money out of the business to pay themself. It also decreases when a corporation pays dividends to its shareholders.
Balance Sheet Formula
The purpose of the balance sheet is to show that the sum of liabilities and owners’ equity is equal to its total assets. So the accounting equation looks like this:
Assets = Liabilities + Owners’ Equity
The sum of assets on one side of the balance sheet is equal to the total liabilities and owners’ equity on the other side. These balance each other out, which is how the balance sheet got its name. This makes sense, because a company pays for its assets by either borrowing money (liabilities) or getting money from its owners (equity).
Small Business Accounting Courses
The Oregon SBDC Network offers classes on small business accounting, budgeting, cash flow management, and QuickBooks—a valuable tool for financial reporting and management. To find a small business accounting or QuickBooks class near you, contact your local Center today.
