A balance sheet provides a snapshot of a business' health at a point in time. It is a summary of what the business owns (assets) and owes (liabilities). Balance sheets are usually prepared at the close of an accounting period such as month-end, quarter-end, or year-end. New business owners should not wait until the end of 12 months or the end of an operating cycle to complete a balance sheet. Savvy business owners see a balance sheet as an important decision-making tool.
Over time, a comparison of balance sheets can give a good picture of the financial health of a business. In conjunction with other financial statements, it forms the basis for more sophisticated analysis of the business. The balance sheet is also a tool to evaluate a company's flexibility and liquidity.
A balance sheet is a summary of a firm's assets, liabilities and net worth. The key to understanding a balance sheet is the simple formula:
All balance sheets follow the same format: If it is in two columns, assets are on the left, liabilities are on the right, and net worth is beneath liabilities. If it is in one column, assets are listed first, followed by liabilities and net worth.
Here is a sample balance sheet for the Doodads Company.
| Assets | |
| Current Assets | |
| Cash On Hand | |
| Cash in Bank | |
| Accounts Receivable | |
| Merchandise Inventory | |
| Prepaid Expenses | |
| Rent | |
| Total Current Assets | |
| Fixed assets | |
| Equipment and Fixtures (less Depreciation) | $ 1,200 |
| Total Assets | |
| Liabilities | |
| Current Liabilities | |
| Accounts Payable | |
| Notes Payable, Bank | |
| Accrued Payroll Expenses | |
| Total Current Liabilities | |
| Long-term liabilities | |
| Notes Payable, 1998 | |
| Total Liabilities | |
| Net Worth* | |
| Total Liabilities and Net Worth |
| *Net Worth = Assets - Liabilities |
Assets
In this section, each type of asset is explained. A worksheet is provided for your use in assembling a balance sheet for your business at the end of this section.
All balance sheets show the same categories of assets: current assets, long-term (fixed) assets, and other assets. Assets are arranged in order of how quickly they can be turned into cash. Turning assets into cash is called liquidity.
Current assets include cash, stocks and bonds, accounts receivable, inventory, prepaid expenses and anything else that can be converted into cash within one year or during the normal course of business. These are the categories you will use to group your current assets. This Business Builder focuses on the current assets most commonly used by small businesses: cash, accounts receivable, inventory, and prepaid expenses.
Cash is relatively easy to figure out. It includes cash on hand, in the bank and in petty cash.
Accounts receivable is what you are owed by customers. The easy availability of this information is important. Fast action on slow paying accounts may be the difference between success and failure for a small business. To make this number more realistic, you should deduct an amount from accounts receivable as an allowance for bad debts.
Inventory may be your largest current asset. On a balance sheet, the value of inventory is the cost to replace it. If your inventory were destroyed, lost or damaged, how much would it cost you to replace or reproduce it? Inventory includes goods ready for sale, as well as raw material and partially completed products that will be for sale when they are completed.
Prepaid expenses are listed as a current asset because they represent an item or service that has been paid for but has not been used or consumed. An example of a prepaid expense is the last month of rent of a lease that you may have prepaid as a security deposit. It will be carried as an asset until it is used. Prepaid insurance premiums are another example of a prepaid expense. Sometimes, prepaid expenses are also referred to as unexpired expenses.
On a balance sheet, current assets are totaled and this total is shown as the line item: Total Current Assets.
In this section, two types of liabilities will be explained. You will continue to use the worksheet and at the end of this section. Liabilities are claims of creditors against the assets of the business. They are debts owed by the business.
There are two types of liabilities: Current Liabilities and Long-Term Liabilities. Liabilities are arranged on the balance sheet in order of how soon they must be repaid. For example, accounts payable will appear first as they are generally paid within 30 days. Notes payable are generally due within 90 days and are the second liability to appear on the balance sheet.
Current Liabilities are accounts payable, notes payable to banks (or others), accrued expenses (such as wages and salaries), taxes payable, the current—due within one year—portion of long-term debt and any other obligations to creditors due within one year from the date of the balance sheet. The current liabilities of most small businesses include accounts payable, notes payable to banks, and accrued payroll taxes.
Accounts payable is the amount you may owe any suppliers or other creditors for services or goods that you have received but not yet paid for.
Notes payable refers to any money due on a loan during the next 12 months.
Accrued payroll taxes would be any compensation to employees who have worked, but have not been paid, at the time the balance sheet is created.
Long-Term Liabilities are any debts that must be repaid by your business more than 1 year from the date of the balance sheet. This may include start up financing from relatives, banks, finance companies or others.
