What is a balance sheet and what is its purpose?
A balance sheet is a document that outlines a company’s finances such as cash flow and debts. Accountants and other finance professionals typically enter and update the balance sheets for their company. Companies typically use a balance sheet because it does the following:
- Contributes to the annual report: Companies can use balance sheets to verify their assets, liabilities and shareholders’ equity at the end of each fiscal year in their company’s annual report.
- Attracts potential investors: Potential investors can access company balance sheets to determine the financial stability of a company before they decide to buy shares. A company with detailed financial records might be more appealing to investors than those with limited documents.
- Helps prepare for tax season: A business can use balance sheets to help them provide accurate tax information during tax season. Balance sheets also provide information about deferred income tax, which could potentially reduce the amount of taxes they pay if they overpaid in the past.
- Gives the opportunity to correct errors: A balance sheet’s layout allows finance professionals to quickly identify the total monetary value of assets, liabilities and equity a company has and apply it to the accounting formula. If the total assets don’t equal the total liabilities and equity combined, then there was likely an error in recording. However, if the total assets equal the sum of the total liabilities and equity, then the balance sheet should be correct.
- Helps create money solutions: When companies need to find money to pay off current liabilities, they can look to their balance sheet to see if they can liquidate any assets. If they have assets to liquidate, they can sell one or multiple assets to pay their debts and remain financially stable.
What is included in a balance sheet?
A balance sheet has three distinct categories: assets, liabilities and shareholder’s equity. Together, assets, liabilities and shareholder’s equity make up this basic accounting formula:
Assets = Liabilities + Shareholder’s Equity
Finance professionals can use this formula to check if a company’s balance sheets are actually balanced. Here are the explanations for what they mean and examples of each:
Assets are anything of monetary value that’s owned by your company or owed to your company. The two main categories of assets are current and non-current assets. Current assets only carry monetary value within their first fiscal year of use. In contrast, non-current assets can be of monetary value longer than one fiscal year. Here are some examples of current and non-current assets:
- Accounts receivable
- Prepaid liabilities
- Stock inventory
- Short-term investments (treasury bills, high-yield savings accounts and government bonds)
- Property or land
- Intellectual property
- Copyrights or trademarks
Liabilities are debts that your company owes, whether it be to customers, employees or business partners. Liabilities can be as current or non-current. Current liabilities are any debts that must be paid by the end of the fiscal year, while non-current liabilities include any debts that can be paid after one fiscal year. Here are examples of current and non-current liabilities you might have in your company:
- Accounts payable
- Income tax
- Short-term bank loans
- Notes payable
- Bonds payable
- Retirement payments
- Deferred taxes
Shareholder’s equity is the estimated amount of money left over after you subtract your total liabilities from your total assets. This sum represents the amount of money that shareholders can expect to receive in return for their investment in your company. Here are some examples of equity:
- Retained earnings
- Preferred stock
- Common stock
- Paid-in capital
Basics of preparing a balance sheet
Before you can benefit from keeping detailed financial records, you need to learn how to create a balance sheet. Here’s how to prepare a balance sheet:
1. Choose a software program
There is a multitude of data entry and accounting-focused software programs that can help you create and design a layout for your balance sheet. Some can even help with calculations for things like shareholder’s equity and the monetary amount of assets to put toward your company’s liabilities.
2. Record the date and accounting period
When you create a balance sheet, make sure you clarify the date and accounting period at the top. This will make it easy to pull financial data from a specific quarter to add to financial reports. It can also help investors determine your financial health at a specific point in time.
3. Identify and record your company assets
Review company documents, read past balance sheets and consult with company officials to determine your company’s current and non-current assets. List each under a section titled "Assets." Next to each asset, include its monetary value. After you record each asset and its corresponding value, add the sum of your current and non-current assets. The total sum is the monetary value of your total assets.
4. Identify and record your company liabilities
Verify and record your company’s current and non-current liabilities under a section titled "Liabilities." Across from each liability, record the monetary amount owed by your company. Next, add the sum of your current and non-current liabilities to get your company’s total liabilities.
5. Use your assets and liabilities to calculate your company’s shareholders’ equity
To help simplify calculating your shareholder’s equity, combine the equity and liabilities sections. Use the equity formula to find the total equity:
Equity = Total Assets – Total Liabilities
For example, if your total assets equal $1,000,000 and your total liabilities equal $900,000, you can find your total shareholders’ equity like this:
Equity = $1,000,000 – $900,000
Equity = $100,000
Once you’ve determined the total amount of your shareholder’s equity, insert that value next to "Total Equities."
6. Use the accounting formula to compare your assets to your liabilities and equity
Once you’ve entered all your company’s financial data relating to assets, liabilities and equity, complete the accounting formula to make sure that your balance sheet has the right information. If you entered everything correctly, your total assets should equal the sum of your total liabilities and equity. For example:
Assets = Liabilities + Shareholder’s Equity
$1,000,000 = $900,000 + $100,000
$1,000,000 = $1,000,000
Balance sheet examples
You can use data-entering software or an accounting program to help you create your balance sheet.
Here’s an example of a basic balance sheet:
|Oct. 30, 2019|
|Paid-in Capital Expenses||$40,000|
Here is another way you can organize your balance sheet:
|Total Current Assets:||$400,000|
|Total Non-Current Assets:||$600,000|
|Total Current Liabilities:||$1,000,000|
|Total Non-Current Liabilities:||$80,000|
|Total Shareholder’s Equity:||$100,000|
Balance sheet FAQs
How often do companies complete their balance sheets?
Companies typically complete balance sheets at the end of each accounting period. This can occur monthly, quarterly and annually, but you can do whatever works best for your business.
What is the difference between a balance sheet and an income statement?
A balance sheet typically displays a company’s debts and valuable assets while an income statement usually shows the amount of a company’s total revenue and expenses.
What does it mean when the total equity is negative?
When you have a negative total equity on your balance sheet, your company owes more money than it’s worth. Depending on your resources, you might consider taking out a loan or seeking an alternative option to settle your debts.
Should I include withdrawals on my balance sheet?
No, you shouldn’t include withdrawals on your balance sheet because withdrawals are contra equity accounts, so you can include them as a part of your balance sheet’s equity section.