What’s included in a balance sheet? How to make one — with example

An important financial exercise, balance sheets are key for business positioning and planning. Here’s where to start when it comes to preparing them…

30 March 2020

 

A balance sheet provides an idea of a company’s financial position by outlining the total assets it owns, in addition to the amounts it owes to lenders or banks, as well as the amount of owner’s equity. All of this provides valuable information to the banker, who uses the figures as a way of determining whether or not a company qualifies for additional credit or loans.

 

Here, we’ll take a look at the ins and outs of a balance sheet and how to get started creating your own version of this essential business document.

 

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How does a balance sheet work?

 

A balance sheet has two sides that must be equal or balance each other out. The thinking behind this is as follows: a company must pay for its assets by borrowing money from lenders or through investors.

 

So, for example, if Company A takes out a loan for £5,000 from the bank, the assets would increase by £5,000, but the liabilities would also increase by the same amount, effectively balancing the accounts.

 

The formula of every balance sheet is thus:

Assets = Liabilities + Owner’s Equity

 

Assets


Assets are the physical (tangible) and non-physical (intangible) resources that a company owns and fall under two major categories: current and long-term.

 

  • Current assets: This category refers to any kind of assets which are equivalent to cash or can be converted to cash within one year, e.g. cash, accounts receivable, inventory, and short-term investments.

  • Long-term assets: This category refers to assets which are used for more than a year, e.g. long-term investments, equipment and manufacturing, capital investments and real estate property.

Colleagues analysing monthly report

 

Liabilities


Liabilities are the second part of a balance sheet and refer to what the company owes. Much like assets, they’re classified under two main categories: current and long-term.

 

  • Current liabilities: These consist of charges that the company should pay out within one year, e.g. accounts payable like bills, insurance and rent.

 

  • Long-term liabilities: These are obligations that a company should meet over a period exceeding one year, e.g. bonds, mortgages and loans.

Equity


Equity is what the owners and stockholders own in the company. This portion of the balance sheet reports how much funding a company has received in exchange for its shares, paid-in-capital and retained earnings. Its value is calculated by subtracting assets of a company from its liabilities, since assets is equal to liabilities plus equity. So, if a company’s total assets are £1,000 and its total liabilities £600, a company’s equity is £400.

 

Why is a balance sheet important?

 

The data displayed on the balance sheet provides a business with a better idea of the financial state of the business in the given time period, revealing information about both liquidity and efficiency in the process.

 

  • Liquidity: Measured more thoroughly by applying one or more ratios to produce a percentage that can be compared against previous, future and market percentages. The ratios most commonly used are the current ratio and the quick ratio.

  • Efficiency: Efficiency measures how well a business is managing its assets including working capital. This provides a better idea of the financial efficiency on a day-to-day basis for the given time period.

 

The balance sheet can also provide insight into a business’s leverage, which can illustrate the amount of risk being taken, as well as the returns – such as returns on investment (ROI), for instance.

 

Understanding a balance sheet

 

Though it may seem difficult for those unfamiliar with accounting practices, the balance sheet is easily interpreted, especially those of small businesses that have fewer entries.

 

While one balance sheet only provides information about the period selected, it can be useful to compare it to balance sheets from previous periods. Combined with the liquidity ratios mentioned above, you can compare your numbers with other businesses to gain an understanding of how a business stands in a particular industry.

Man writing figures shown on calculator

 

 

 

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Preparing a balance sheet

 

Assets

  • Line 1 is the firm’s cash account. SME’s must keep some cash on hand for day-to-day transactions, while business firms should do the same in case of emergencies, or to take advantage of any bargains they might find in the marketplace.
  • Line 2 is accounts receivable. This represents what your credit customers owe you if your firm extends credit. The accounts receivable figure (as well as other accounts) are accurate for the day on which the financial statement is developed.
  • Line 3 states the firm’s inventory, i.e. the products a business has for sale
  • Line 4 states fixed assets, and includes any equipment and vehicles, land and buildings you own. These assets refer to the large and highly valued assets that are owned by your business firm and those that can depreciate over time.
  • Line 5 states the value of the asset accounts totalled up, i.e. the value of everything your firm owns.

 

Liabilities

 

  • Line 6 lists accounts payable, which are the short-term credit accounts you owe your suppliers.
  • Line 7 shows any long-term bank loans or loans from other sources that you’ve taken out with a maturity of more than a year. You may have used long-term loans to keep your firm solvent.
  • Line 8 shows the amount of owners’ capital that has been invested in the firm i.e. the money that the owner(s) and any other investors have put in the firm.
  • Finally, line 9 states the total number of liabilities and equity; the total amount the firm owes plus the owners’ investment in the firm. The total of the liabilities and equity must equal total assets as the firm can’t own more than it owes.

 

An example balance sheet

 

A basic, year-end balance sheet might look like the following:



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