Dive deep into the world of balance sheets. From basic definitions to intricate details, our comprehensive guide simplifies financial jargon for everyone.
Keeping track of your financial transactions is one of the most important things you can do in your business. It ensures you have complete visibility into your finances, costs, expenses, liabilities and assets. It also ensures you are ahead of the game regarding taxes, VAT, and other essential admin parts of doing business.
Which is why you need a balance sheet.
A balance sheet is designed to help you stay on top of your assets, shareholders and liabilities. Working alongside your income statement [link to our blog post on this] and cash flow statement, your balance sheet gives you an excellent overview of your business performance.
For business owners, it’s a snapshot of your equity.
For investors, it’s visibility into capital structure and rates of return.
For accounting, it’s a financial statement that shows you what the business owes, what it owns, and its investments.
Your balance sheet gives you your total assets minus the sum of your liabilities and shareholder equity. It also can be used alongside financial ratios that allow you to assess your financial well-being as a company, detect trends, and catch potential problems.
Key Components of a Balance Sheet?
Your balance sheet is traditionally divided into two columns. The left column includes all your assets, while the right includes your liabilities and shareholder equity.
In your asset column, your assets are further divided into two categories – current assets and those that are non-current. The same applies to the liability column. Current items include cash and inventory, while non-current items refer to property, debt and equipment.
If you look at the template below, you can see how assets and liabilities are broken down to create a clear picture of a company’s performance over a two-year period. Using a well-designed template will allow you to easily manage your numbers to gain a clear picture of your business performance over time.
The assets owned by a company are defined as items that have economic value. These can be anything from cash to inventory to materials to furniture and property.
Current assets are those items that have economic value, and that can be turned into cash within a one-year period. Current assets include stock, inventory, cash and liquid assets.
Non-current assets are those items that have economic value but are not immediately accessible as a cash dividend. These are also known as long-term assets, and they do generate income but not at the same pace as current assets. Non-current assets include items such as property, equipment, investments and trademarks.
Liabilities, of course, are the opposite of assets. These are what the company owes and include things such as loans, accounts payable, mortgages, rental costs and expenses. When subtracted from assets, they paint a picture of your business that benefits shareholders and investors.
Current liabilities, like assets, are short-term, but, in this case, they refer to what the company owes rather than what it owns. These include short-term debt, income tax, VAT and accounts payable.
Non-current liabilities are long-term financial obligations that include loans, leases, bonds and deferred revenue.
Understanding shareholder’s equity is important. This is defined as the amount of money that the owners of a business have invested into that business. It includes funds that have been invested and funds that have been re-invested. It is also the amount that a company owes its shareholders.
Reading and Interpreting a Balance Sheet
Now that you know the different components that make up a balance sheet, you need to understand how to read the balance sheet. It is, after all, the equivalent of a full body scan, telling you the health of your business.
The most important considerations for your balance sheet include:
- It is a summary of your business that offers you visibility into your financial status and how attractive your business is to investors.
- Internally, it provides stakeholders, employees, and executives with insight into the success or failure of the business.
- Externally, it provides investors with insights they can use to determine whether or not they want to invest in the business.
- The date on the balance sheet tells you the reporting period from one year, and this should be compared against a similar reporting period from a previous year.
- Different balance sheets use different reporting formats depending on where you are in the world. Countries outside of the United States tend to use the International Reporting Standards (IFRS), so they list their items from those that are the least liquid (non-current) to the most liquid (current).
- It provides insight into current and non-current assets and liabilities and the company’s overall liquidity.
Your balance sheet can also be used to assess how your business is performing against common financial ratios. These include:
- Working capital ratio: this is worked out by subtracting current assets from current liabilities and shows how easily the company can turn assets into cash.
- Quick ratio or acid test: this is your current assets subtracting inventory and prepaid expenses or current liabilities to determine how quickly you can pay off your current liabilities with current assets.
- Debt-to-equity ratio: this determines how much-borrowed money is being used to pay for the business to operate and whether or not shareholder equity can cover these debts. This is worked out by taking total liabilities and dividing it by total shareholder’s equity.
Common Misconceptions About Balance Sheets
The balance sheet is an invaluable tool but comes with its fair share of misconceptions and confusing perceptions. Here are some of the most common – debunked.
Not everyone needs one. True! Not every business needs to maintain a balance sheet. This comes down to best practices and the size of the company, and what accounting practices you already have in place.
Creating a balance sheet is easy. True. It is time-consuming and precise. Yes, there are templates designed to help you manage this effectively, but you have to ensure your data is accurate, and you need to keep meticulous records so your balance sheet remains relevant. It sounds hard, but technology has made it a lot easier today than ever before.
A balance sheet is compulsory. False. You don’t have to have one unless you’re a publicly traded company, then different rules apply.
You only need to worry about profit. False. It is an excellent tool for all companies as it gives you a very clear picture of your business and its performance.
The Evolution of Balance Sheets
Balance sheets have always provided organisations with the financial visibility they need to make better decisions. They have also always been complex, fiddly and time-consuming. They require a lot of accurate data to ensure they give the right results to decision-makers.
This has changed. Yes, balance sheets still need all the fiddly information. Yes, they are still absolutely critical for investors and shareholders. But, thanks to technology and advanced solutions, managing, interpreting, and populating a balance sheet has become significantly more manageable and more efficient.
Navigating Balance Sheets
A well-adjusted balance sheet can make all the difference in managing your business, engaging with investors, and planning your financial future. A balance sheet built on solid foundations can help you grow and scale your business while catching any potential issues before they become glaring problems.
Using intelligent tools such as Blue dot’s VAT calculator, you can manage your liabilities far more efficiently to ensure that your equity and value are accurately represented on your balance sheet. Blue dot is the world’s leading deep AI tax compliance platform, providing a 360-degree contextual view of all your employee transactions, ensuring tax compliance and reducing exposure. We ensure your business is ahead of the curve in accounting, financial and expense management, and powers growth.