Running a business can be a perilous task; any business owner, whether that business is operating out of a garage or central city office, must keep track of a number of things that ultimately determine whether the business will be a success or a failure.
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. Let’s get started with understanding what a balance sheet is and how it can help your burgeoning business.
What is a Balance sheet?
Balance sheets calculate the net worth of your company by allowing you to total your business’s assets and liabilities- you can then subtract your total liabilities from your total assets and thus find your business’s net worth (also known as shareholder equity). An example of a balance sheet runs as follows; a balance sheet’s format will include a left column or top section totalling your business’s assets, which are items of value that your business owns. These can include investments like stocks and bonds, fixed assets like real estate and vehicles, current assets like cash and cash equivalents and intangibles, which are assets like copyrights, trademarks, licenses and patents. The right column or bottom section of a balance sheet will show your business’s liabilities, which represent the total cash value of what your business owes to other entities; these include current liabilities, like accounts payable, and long term debt, like mortgages. Once the total liabilities of your business have been subtracted from total assets, you can find your companies net worth or shareholder equity- the shareholder’s ownership stake once all debts have been paid. Balance sheets are an essential part of financial reporting and ensure that your business continues to run smoothly without falling into debt.
Income statement vs balance sheet
Balance sheets and income statements are both vital tools that are used to determine the financial state of your business, however they operate in distinctly different ways. Whilst a balance sheet provides a snapshot of your business’s assets and liabilities at a certain time, an income statement shows your company’s income and expenses over an extended period of time (usually one year). The formula of a balance sheet shows assets, liabilities and shareholder equity, whereas an income statement simply shows revenues and expenses (shown as credits and debits). Perhaps the best way to show the difference between the two is in explaining their alternate functions. An income statement is used for seeing whether the company is operating at a net loss or profit, whereas a balance sheet is often much more detailed, as it requires a full inventory of every asset and liability a company has on its books at any given time.
1. Helps to evaluate the business financially as a whole
The most important thing about running a business undoubtedly is knowing where it stands financially. Balance sheets detail every single asset and liability your company faces at a certain time and therefore are the most important tool in evaluating the finances of every aspect of your business. However, balance sheets do not just benefit the business owner; they are an important device for potential investors, who often rely on them to make a decision on whether to invest or not. A regular outputting of balance sheets means that both investors and the business owner can track what is costing the business money and what the financial health of the business is, which can lead to renewed investments.
2. Helps determine efficiency, liquidity and productivity
Efficiency is when a business makes the best possible use of its resources by maximising outputs from given inputs and therefore minimizing their costs. Balance sheets can draw attention to areas of your business that may be progressively making or losing money, and thus help with determining your efficiency. Liquidity refers to the availability of “liquid” assets to your business- assets that you can quickly purchase or sell without causing a drastic change in their price; balance sheets can highlight these “liquid” assets and their net worth. Finally, productivity, a measure of the efficiency of labour, can be determined through calculating its total cost as a liability.
3. Keep track of inventory
Inventory (a complete list of items such as goods in stock) is one of the most important parts of any business; insights into the successes and failures of your inventory is crucial; luckily, balance sheets provide this insight. For example, when you note that there is a high net worth of inventory on your balance sheet, you know that there is a risk of products becoming obsolete and can make decisions on whether to reduce the price of your inventory based on that. This is also important information for investors; by keeping track of your inventory you are able to prevent spoilage, shrinkage and obsolescence of your inventory, all of which makes your business more attractive to invest in.
4. Keep track of cash
Balance sheets also help you keep track of cash. Current assets form a key part of the assets section of your balance sheet; these are assets that can be converted into cash within the next twelve months, and includes cash in the bank, which can be used to pay your bills, your payroll, and yourself; accounts receivable, which is when you make a sale (and thus incur the cost of providing the service/product) and now are waiting to be paid; and your inventory. A balance sheet helps you keep track of all these individual current assets and also allows you to total them so that you can see your cash total.
5. Gives you an overview of any liabilities you have
Liabilities are not necessarily a bad thing! Every business must after all buy something in order to sell something, such as property, a vehicle, or labour. Liabilities can include loans, accounts payable, mortgages, deferred revenues, earned and unearned premiums, and accrued expenses. In general, a liability is a legal financial debt or obligation that your business must pay back; it is therefore extremely important to keep a constant track of them, as they affect your business’s net worth and shareholder equity. Balance sheets allow liabilities to be easily managed and you can track their payment over time; all of which is important information for investors too.
6. See if your customers are paying on time
Your business may be a service where, like a Mechanics, Glaziers, or insurance providers, where your customers do not have to pay upfront. Balance sheets are useful for making sure that your customers still pay for the service that they receive. Your balance sheet can help you track customer payments through its accounts receivable section; most receivables operate in the form of lines of credit and are due within a short period of time; to encourage quick payment, some businesses offer discounts to customers who pay before the end of the determined pay period- a balance sheet helps to record all of this down and makes it easy to keep track of when customers are paying. You can then learn how to deal with customers that aren’t paying on time, so that you can get your money back when you need it.
Use a balance sheet template to help
Balance sheets can still be difficult to figure out! Luckily, many balance sheet templates are available online so that you can figure out the right balance sheet format for your business. Products such as Microsoft excel offer templates for you to follow which can make the sometimes daunting process of making a balance sheet seem slightly easier to achieve.
Get a friend or professional accountant to help
The key part of a business is people, and so if you struggle to understand the fundamentals of a balance sheet then don’t be afraid to ask a friend to help! Working together to create a balance sheet can be helpful as you will have two people working together to ensure that nothing is “swept under the rug” or forgotten. Alternately, professional accountants will be able to provide you with high quality and accurate balance sheets once you’re ready to attract investors to your business.
Learn the basics of creating a balance sheet
The benefits of even basic balance sheets are broad, as has been shown above. Now that you understand those benefits, it’s helpful to get started on a basic balance sheet; if you are starting out on your own, then find a template that suits your business, remember the two broad sections of your assets and liabilities and get started now!