Soaring profits, repeat customers and happy employees indicate that a small business is booming, right? In most cases, yes. However, many small businesses that appear to be financially fit are actually dealing with underlying issues relating to cash flow and liquidity, and the warning signs are not always visible for business owners to see. If these issues are not discovered and addressed in a timely manner, they can wreak havoc on a business’s finances and be difficult to resolve.
One way to evaluate the overall financial health of a business is to prepare a balance sheet at the end of each accounting period, such as month-end, quarter-end or year-end. If you do not fully understand what a balance sheet is or how to prepare one, this Balboa Capital blog article is your business balance sheet guide. It has the important information you need to know.
What is a balance sheet?
Simply put, a balance sheet is a comprehensive financial statement that lists all of your business’s assets, liabilities and equity. Your balance sheet gives you a bird’s-eye view of your business’s financial position for a specific timeframe.
If you want to how much your small business owns, or how much money it owes, all you need to do is check your balance sheet. In the event that you need additional credit or small business funding, your lender might ask to see your balance sheet. Doing so can validate your financial situation and help accelerate the funding process.
Accuracy is important.
Before you can prepare a balance sheet, you need to make sure that your accounting books are accurate and contain all of the necessary records, such as bank statements, expenses and invoices. If any records are missing or inaccurate, your balance sheet will not reflect your business’s actual worth. An inaccurate balance sheet can cause you to make poor business decisions, hinder your ability to borrow, and even present you with legal problems. Therefore, it is a good idea to hire a business accountant or a bookkeeper if you do not already have one on your staff.
How to prepare a balance sheet.
Preparing a balance sheet is fairly simple and straightforward as long as your financial records are accurate and up-to-date. There are several steps to follow to make your own balance sheet, and we walk you through them here:
- To get started, you will need to choose the reporting date and period. In most cases, the reporting date is the final day of the reporting period. For example, if you want a balance sheet for the first quarter of the year, the reporting period will be from January 1 through March 31, and the reporting date will be March 31.
- The next step is to add up all of your assets as of the reporting date. The preferred way to do this is to have two line items, one for current assets and one for noncurrent assets. Current assets include cash, inventory, accounts receivable and prepaid expenses. Noncurrent assets include property, business equipment, long-term investments and intangible assets. Once you finish listing your current and noncurrent assets, add both line items together.
- Step three involves identifying your liabilities and separating them into two different line items, one for current liabilities and one for noncurrent liabilities. Some of the most common current liabilities include accounts payable, office rent, employee payroll and customer/vendor prepayments. Noncurrent liabilities include long-term business loans, deferred income taxes and long-term property/equipment leases. Follow the same step that you did with your assets and total both line items together.
- The fourth step in preparing a balance sheet is to determine your business’s equity, which is the book value of your business if all of your assets were liquidated and all of your debts were paid off. Your business’s equity will be determined based on the legal structure of your small business. If you are a solo business owner of a private company with no partners or shareholders, this will be an easy task. If you have partners, or if your business is publicly traded, your shareholder’s equity will need to included in your balance sheet.
- The fifth and final step is to add your total liabilities to your total shareholders’ equity to see if this number is equal to your total assets. For example, if your business has $35,000 in total liabilities and $150,000 in total shareholders’ equity, the combined total is $185,000. If you have $185,000 in your total assets column, you have an accurate balance sheet.
Analyzing the results.
Once your balance sheet is complete, you need to review it to check for discrepancies. Remember, each side of your balance sheet must equal the other (total assets = total liabilities + total shareholder equity). If the two match, you are all set. However, you should double-check each line item on your balance sheet to look for potential inconsistencies or problems. For example, if your most recent balance sheet shows a sharp decrease in assets or liabilities when compared to the previous time period, you will see an effect on your equity. This is also a sign that your business’s financial strength is decreasing.
Your balance sheet is one of several important financial statements that provide insight into your financial situation. Other common financial statements include profit and loss statements, income statements and cash flow statements. Therefore, make sure you stay on top of your accounting records to ensure that your balance sheet is accurate.
The information in this blog post has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, investing or accounting advice. You should consult with your accountant, lawyer or tax advisor before making any business decisions.