It’s important business owners and accountants understand how to read and interpret balance sheets. These documents offer a quick view of a business’s financial standing. Without this snapshot, business owners and accountants may make decisions that have negative repercussions on their companies’ financial standing.
In this article, we cover:
- What is a balance sheet?
- Assets
- Liabilities
- Equity
- Why are balance sheets important?
What is a balance sheet?
A balance sheet is one of several major financial statements you can use to track spending and earnings. Also called a statement of financial position, a balance sheet shows what your company owns and what it owes through the date listed, as Accounting Coach stated. It displays this information in terms of your company’s assets, liabilities, and equity.
Assets are any items your business owns. Liabilities are payments your business needs to make. Equity is the amount your business’s shareholders own. On balance sheets, the assets are ideally equal to, or balance out, the liabilities and the equity.
See your business finances clearly
Download our balance sheet template to summarize your business finances in minutes
Get it now
Assets
There are two primary types of assets: current and noncurrent. Current assets are items your business has acquired over time that will be used up or converted into cash within one year, or one business cycle, of the date on the balance sheet. Prepaid insurance, accounts receivables, temporary investments, cash, inventories, and liabilities are considered current assets.
Noncurrent assets are any fixed assets or items your business owns. Things that fall into this category are office equipment, building property, land, long-term investments, stocks, and bonds.
Liabilities
Just like assets, there are current and noncurrent liabilities. Current liabilities represent payment obligations your company has to pay within 12 months of the date on the balance sheet. For example, an outstanding bill to an equipment supplier could be a current liability, as could salaries payable and income taxes payable.
Noncurrent liabilities are amounts your company has more than one year to pay. Bondholder and bank debt are considered noncurrent liabilities. You and your accountant can identify the liabilities on balance sheets by looking for the word “payable.” Again, these liabilities are some of the sources of your company’s assets.
See your business finances clearly
Download our balance sheet template to summarize your business finances in minutes
Get it now
Equity
Another asset source is equity. If you are the sole proprietor of your business, this is referred to as owner’s equity. If your business is a corporation, equity is called stakeholder’s equity. When all liabilities are subtracted from your company’s assets, the result is equity.
Equity is made up of paid-in capital and retained earnings. Paid-in capital is the amount each shareholder initially paid for his or her stock. Retained earnings refers to the amount of money your business didn’t sell to shareholders and instead reinvested into itself.
Why are balance sheets important?
It’s clear that balance sheets are critical documents because they keep business owners like you informed about your company’s financial standing. As Inc. magazine pointed out, many business owners fail to recognize their companies are in trouble until it’s too late. This is because some business owners aren’t examining their balance sheets. Typically, if the ratio of your business’s assets to liabilities is less than 1 to 1, your company is in danger of going bankrupt, and you’ll have to make some strategic moves to improve its financial health.
Balance sheets are also important because these documents let banks know if your business qualifies for additional loans or credit. Balance sheets help current and potential investors better understand where their funding will go and what they can expect to receive in the future. Investors appreciate businesses with high cash assets, as this insinuates a company will grow and prosper.
The balance sheet is a snapshot of a business’s financial records at a given date. The total of the owner’s equity is the book value of your business as at that date.
This report helps asmall businessowner quickly understand what their business is worth.
A balance sheet can help you identify trends in yourbusiness’s finances, particularly when it comes to relationships with customers and suppliers.
See your business finances clearly
Download our balance sheet template to summarize your business finances in minutes
Get it now
FAQs
The term balance sheet refers to a financial statement that reports a company's assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company's capital structure.
What is a balance sheet and why is it important? ›
A balance sheet is a versatile document that offers a snapshot of a company's or individual's finances at a given point in time. Businesses can use balance sheets to develop plans for the future and present a picture of their financial health to investors or other outside entities.
What is the balance sheet answer in one sentence? ›
A balance sheet is a financial statement that contains details of a company's assets or liabilities at a specific point in time. It is one of the three core financial statements (income statement and cash flow statement being the other two) used for evaluating the performance of a business.
Why are balance sheets important to managers? ›
We should consider the balance sheet an analysis tool for any business, because it shows the overall situation of its accounts. It supplies managers with financial data that will help them drive their company's profitability and rate of return on investment.
What is the importance of financial balance sheets in managing accounts efficiently? ›
Balance sheets help keep track of assets and liabilities, providing a financial snapshot of what your business owns and owes at one point in time and thus, along with other accessories such as time tracking, serve as an essential tool for your business.
What is an example of a balance sheet? ›
A Balance Sheet Example
The company's assets total $60,173, including $37,232 in current assets and $22,941 in noncurrent assets. The company's liabilities total $16,338, including $14,010 in current liabilities and $2,328 in noncurrent liabilities.
What is the purpose of a bank balance sheet? ›
A bank balance sheet is a key way to draw conclusions regarding a bank's business and the resources used to be able to finance lending. The volume of business of a bank is included in its balance sheet for both assets (lending) and liabilities (customer deposits or other financial instruments).
What balance sheet summarizes? ›
A balance sheet summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. It is one of the fundamental documents that make up a company's financial statements.
What are the three types of balance sheets? ›
The 3 types of balance sheets are:
- Comparative balance sheets.
- Vertical balance sheets.
- Horizontal balance sheets.
The balance sheet displays the company's total assets and how the assets are financed, either through either debt or equity. It can also be referred to as a statement of net worth or a statement of financial position. The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity.
The purpose of a balance sheet is to give interested parties an idea of the company's financial position, in addition to displaying what the company owns and owes. It is important that all investors know how to use, analyze and read a balance sheet. A balance sheet may give insight or reason to invest in a stock.
What are the advantages and disadvantages of a balance sheet? ›
Pros and cons of using a balance sheet
| Pros | Cons |
|---|
| Provides a snapshot of liquidity | Has limitations as it doesn't show growth over time, so it may not be best for predicting the future |
| Understand overall leverage, when comparing liabilities to equity | Is best used in conjunction with other financial statements, not on its own |
1 more rowJul 18, 2024
Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole.
What is the balance sheet and why is it important? ›
A balance sheet is a financial statement that reports a company's assets, liabilities, and shareholder equity. The balance sheet is one of the three core financial statements that are used to evaluate a business. It provides a snapshot of a company's finances (what it owns and owes) as of the date of publication.
What are the four purposes of a balance sheet? ›
The balance sheet provides information on a company's resources (assets) and its sources of capital (equity and liabilities/debt). This information helps an analyst assess a company's ability to pay for its near-term operating needs, meet future debt obligations, and make distributions to owners.
What are the three main sections of a balance sheet? ›
A business Balance Sheet has 3 components: assets, liabilities, and net worth or equity. The Balance Sheet is like a scale. Assets and liabilities (business debts) are by themselves normally out of balance until you add the business's net worth.
What will a balance sheet tell you? ›
Introduction. The balance sheet provides information on a company's resources (assets) and its sources of capital (equity and liabilities/debt). This information helps an analyst assess a company's ability to pay for its near-term operating needs, meet future debt obligations, and make distributions to owners.
What is considered a strong balance sheet? ›
Entities with strong balance sheets are those which are structured to support the entity's business goals and maximise financial performance. Strong balance sheets will possess most of the following attributes: intelligent working capital, positive cash flow, a balanced capital structure, and income generating assets.
What are the disadvantages of a balance sheet? ›
There are three primary limitations to balance sheets, including the fact that they are recorded at historical cost, the use of estimates, and the omission of valuable things, such as intelligence. Fixed assets are shown in the balance sheet at historical cost less depreciation up to date.
