Balance sheets along with income statements are statements that are not only used to evaluate the health and financial position of a business but are the primary statements that lenders and investors will look at. In our previous article, we talked about creating an internal income statement to analyze our financial data.
Here we will discuss the importance of an accounting balance sheet, look at an example to get an understanding of the balance sheet format.
If you just came for the balance sheet template, scroll to the bottom of the page!
What is a Balance Sheet?
An accounting balance sheet is a portrait of the financial standing of a business at a point in time. It shows what your business owns and what it owes. This financial report is similar to a personal financial statement that someone may fill out when applying for a loan to show their assets and liabilities.
The balance sheet is an important financial statement as it will show a summary of a company’s assets, liabilities, and shareholders’ equity at a specific point in time.
It is usually prepared at the end of the month, quarter, or year.
Why Prepare a Balance Sheet?
The balance sheet is one of the three primary financial statements that a business uses to evaluate its financial health. This can be a very valuable tool in evaluating financial performance and making financial business decisions.
Balance Sheet Terms Explained
There are a lot of terms used when preparing a balance sheet. A few of the more common terms are explained below:
Assets – Assets are items owned by the business. In the assets section of the balance sheet, you will notice that there are current and long-term assets.
Current assets are the same as short-term assets and those are assets that are expected to be sold or turned into cash within one year. Cash is considered the most liquid of all assets, but other short-term assets include items like accounts receivable and prepaid rent or prepaid insurance..
Long-term assets or non-current assets are assets not expected to take more than one year to be consumed or converted into cash. Long-term assets often include items like real estate or machinery.
The reason for dividing current and long-term assets is that these categories can be used to measure the liquidity of a company by turning assets into cash.
Accounts Receivable – Money owed by customers who purchased goods or services on credit that was provided by the company.
Current Liabilities – A current liability is a loan due to creditors within the next 12 months from the beginning date of the reporting period.
Accounts Payable – Similar to accounts receivable, accounts payable are short-term loans, typically owed by the business from purchases made on credit from suppliers or vendors.
Taxes Payable – Taxes that have accrued but have not yet been paid. One example would be payroll taxes. The wages have been paid to the employee but payroll taxes haven’t been paid yet as they weren’t due at the specific time period.
Long-term Liabilities – Similar to current liabilities, but a long-term liability is a debt that is due more than one year out from the date being reviewed.
Retained earnings – Earnings that are reinvested in the business after the deduction of any dividends.
Current Portion of Long-Term Debt – Amount of principal that will be due within one year of the reporting date.
Owners’ Equity (or Shareholders’ Equity) – Owner’s equity is sometimes referred to as stockholder equity, net worth, or paid-in capital and is the amount owners have invested in the business minus any withdrawals (not including salaries) taken since the business began.
What is Included in a Balance Sheet?
At the core, the balance sheet includes the assets and liabilities of the business along with the owner’s equity. The typical balance sheet format is as follows:
Types of Assets on the Balance Sheet
The assets on the balance sheet can include current assets (sometimes called short-term assets) and then long-term assets. Some of the assets include:
- Accounts Receivable
- Buildings & Improvements
- Furniture & Fixtures
- General Equipment
- Intangible assets
Types of Liabilities on the Balance Sheet
After the assets, the liabilities show up on the balance sheet. The company’s liabilities are debts for the business and will include short-term and long-term liabilities. Some examples of liabilities include:
- Accounts Payable
- Taxes Payable
- Salaries/Wages Payable
- Interest Payable
- Owner’s Equity – Shows the amount of money invested in the business along with retained earnings.
What is the Order of Items on the Balance Sheet?
Balance sheet accounts are listed in a specific order depending on if they are assets or liabilities.
Assets are ordered in terms of liquidity or how long it would take to change into cash. The most liquid assets start at the top. Cash would obviously be first then followed by accounts receivable, inventory, fixed assets like land, equipment, and buildings, with goodwill at the end because that typically represents the sale of the business.
Total liability is typically ordered with total current liabilities first and then non-current liabilities. The order varies with the other liability items by the business.
Why Does a Balance Sheet Balance?
The balance sheet should always balance because of the accounting equation Assets = Liability + Equity.
The reason for this equation is that if you take the total assets of the business and then subtract the total liabilities, you are left with the amount that belongs to the business owners.
Take a non-business example to maybe better this easier to understand. Let’s say you own a home and it has a value of $200,000 with a mortgage of $75,000.
Assets = Liability + Equity
$200,000 = $75,000 + $125,000
Simple Balance Sheet Template & Example:
If you are using double-entry accounting software, a company balance sheet is very easy to create. You can also run a comparison between two dates to compare your current accounting balance sheet with a previous accounting period.
Single-entry bookkeeping systems such as my free balance sheet template spreadsheet do not include the ability to track assets and liabilities, so generating one can be a little more tedious.
When the balance sheet is completed and the starting and ending cash balances that are calculated, the Cash Flow Statement is the next financial statement to tackle.
Some of the common questions that get we are asked about balance sheets are answered below:
What are balance sheet accounts?
In general ledger accounts, there are two primary types which include the balance sheet and income statement. Balance sheet accounts are permanent or real accounts and are used to organize, record, and sort transactions.
What is a horizontal balance sheet?
A horizontal balance sheet is a financial statement with additional columns to show changes in the amounts of assets, liabilities, and equity of a business over multiple years. This makes it easier to see the financial performance of a business as multiple years are on one page.
How do I check for mistakes?
The easiest way to check a balance sheet for mistakes is to see if the right side (total assets) are equal to the right side (liabilities plus owner’s equity).
What notes are typically prepared?
The notes (or footnotes) on the balance sheet contain information that is critical to properly understanding and analyzing a company’s financial statements and are used to inform a reader about significant accounting activities like commitments made by the company, potential liabilities & losses and procedural changes. The notes contain information that is critical to properly understanding and analyzing a company’s financial statements.
A few examples of footnotes in the balance sheet could include claims against the company, methods of depreciation, or the method of valuing inventory.
Where does accumulated depreciation go?
The accumulated depreciation account should go on the asset side of the balance sheet. Accumulated depreciation is the cumulative total amount of depreciation that has been reported as an expense on the income statement and is increased with a credit and decreased with a debit because its function is to decrease the cost of a company asset as it loses value over time.
What is a pro forma balance sheet?
A pro forma balance sheet makes estimates on the future effects on assets, liabilities, and net worth after applying assumptions and projections to the current performance of the company.
What accounts appear on a balance sheet?
The accounts that commonly show up on a typical small business balance sheet may include
Current Assets – cash, accounts receivable (A/R), inventory and pre-paid expenses
Fixed Assets – land, buildings, and equipment
Liabilities – accounts payable (A/P), accrued expenses, short-term debt, and long-term debt
What is the balance sheet equation?
The balance sheet equation is assets = liabilities + owner’s equity.
What is the statement of financial position?
The statement of financial position or (SOFP) is just another name for the balance sheet.