A balance sheet is an essential way to evaluate a business’ financial health, and can be calculated every month, quarter or half-year to create a snapshot of a company’s net worth. Creating an annual balance sheet will help you evaluate the equilibrium between your company’s assets against its liabilities, to determine the overall financial strength and value of your business.
Understand the Basic Equation
The following equation is a simplified representation of what a Balance Sheet calculates: the total sum of your company’s assets equals the value of the company’s liabilities and owner’s equity. Assets = Liabilities + Owner’s Equity
As with any math equation, you can play around with the equation to isolate one category. Most business owners and investors use the following equation to calculate the value of the company’s equity. Owner’s Equity = Assets – Liabilities
Assets, money, investments and products the business owns that can be converted into cash: These are what put companies in the financial positive. A thriving company should have assets that are greater than the sum of its liabilities; this creates value in the company’s equity or stock, and opens up opportunities for financing.
It’s important to list your assets by their liquidity, the facility by which they can be turned into cash, starting with cash itself and moving into long-term investments at the end of the list. For the purpose of an annual balance sheet, you can separate your list between “Current Assets,” anything that can be converted into cash within a year or less, and “Fixed Assets,” long-term possessions that can be sold or that retain value down the line, minus depreciation.
“Current Assets” may include:
- Cash: All money in checking or savings accounts
- Securities: Investments, stocks, bonds, etc.
- Accounts Receivable: Money owed to the business by a client or customer
- Inventory: Any products or materials that have already been created or acquired for the purpose of sale
- Pre-paid Insurance: Any payments made in advance for business insurance coverage or services (this tends to be paid in advance for the year).
“Fixed Assets” may include:
- Supplies: Important objects used for business operations (manufacturing equipment, computers, office furniture, company cars, etc.)
- Property: Any office building or land owned by the business
- Intangible Assets: Intellectual property such as patents, copyrights, trademarks and other company rights that retain intrinsic value
Liabilities are the negative part of the equation; these include operational costs, debt and material expenses. Generally speaking, the lower your liabilities, the greater the value of your company (and equity) can be. “Current Liabilities” include cash spent, as well as any debts that must be paid out within one year, while “Fixed Liabilities” refer to bills due anytime after one year.
“Current Liabilities” may include:
- Accounts Payable: Money owed by a business to its suppliers or partners
- Business Credit Cards: Company credit card bills due
- Operating Line of Credit: Any money owed to a bank that has extended the business an operating line of credit
- Taxes Owed: Any federal and state taxes owed for one year
- Wages and Payroll: Employee compensation, including wages, medical insurance, etc.
- Unearned Revenue: Any revenue garnered from a service or product that has yet to be delivered to the customer or client
“Fixed Liabilities” may include:
- Long-Term Mortgages: Property or building mortgage expenses
- Bonds payable: Long-term bonds owed to the government, as well as any interest paid on the bond (this interest is often semi-annual and can be added to “Current Liabilities”)
- Pension Benefit Obligations: The total amount of money the company owes to employee pension plans up to the current date
- Shareholder’s Loan: A form of financing provided by shareholders
- Car Loan: Any long-term car loans on company vehicles (plus insurances costs)
Owner’s Equity = Assets – Liabilities
The value of your assets minus your liabilities will result in an estimation of the value of your company’s capital. If this equation results in a negative net worth, this can be dangerous for a small business; it will make it difficult for to secure financing, which can be troubling for a company whose expenses are already eclipsing its profits.
If, however, a company has positive equity, this means that business owners have the option of acquiring capital by selling part of their business through equity, stocks and/or dividends.
In a sole proprietorship, this is called the “Owner’s Equity”; in a corporation, this is called “Stockholder’s Equity,” and it can include common stock, preferred stock, paid-in capital, retained earnings, etc.
“Equity” may include:
- Opening Balance Equity: The initial investment into the company
- Capital Stock: The common and preferred stock a company issues
- Dividends Paid: Profits paid out to shareholders by a company (applies to corporations)
- Owner’s Draw: Portion of the revenue used by company’s owner (applies to sole proprietorships)
- Retained Earnings: The sum of a company’s consecutive earnings since it began
A solid balance sheet is an essential financial statement and part of a complete financial report. It can be used to secure financing or take a snapshot of a company’s current financial state, but it can also be used to evaluate the worth of your company over time. Comparing your “Current Assets” minus “Current Liabilities” on a yearly basis will paint a picture of your company’s annual growth and expenses, which may have room for improvement. Calculating “Fixed Assets” minus “Fixed Liabilities” can provide a more long-term view of the company’s value over time and its ability to pay back long-term debts or expenses built up over many years. Remember, the expenses of different companies may vary greatly, so don’t forget the assets and liabilities that are specific to your industry or area.
Ref: 5 Simple Ways to Create a Balance Sheet - by Rochelle Bailis