How to create balance sheet for small businesses?
Creating a balance sheet after periodic intervals is one of the core functions of any accounts team and a necessary part of running a successful business. By balancing out your total assets, liabilities, and shareholders’ equity you can get a comprehensive overview of your organization's financial health.
A balance sheet is essentially a document that helps you get an overview of your company’s financial health on a particular date. By subtracting total liabilities and shareholder equity from total assets a balance sheet calculates the “book value” of an organization.
It gives internal and external auditors, investors, etc. insight into what the company owns, what it owes, and how much investment it has accrued. A balance sheet also helps you determine the net worth of your company at any given point in time.
The 3 fundamental elements that constitute a balance sheet include:
If your company holds any cash and/or property then those are your balance sheet assets. The main categories that assets are divided into include:
Liquid vs. non-liquid assets: Assets that can be easily encashed, within or under a year, are called Liquid Assets (e.g. raw materials, other inventory items, etc.). Similarly, assets that cannot be converted into cash easily or those which, if converted, would create losses are your Non-Liquid or long-term assets (e.g. property, real estate, etc.). These categories are also referred to as current/fixed assets.
Tangible vs. intangible assets: Physical assets that are owned by your company (e.g. land, buildings, inventory, etc.) are called Tangible Assets. On the other hand, any intellectual property you own that can bring value in the future is called an Intangible Asset (e.g. domain ownerships, patents, trademarks, etc.).
Operating vs. non-operating assets: Assets required to run regular day-to-day operations are called operating assets (e.g. cash, manufacturing equipment, etc.). Non-operating assets are those that are not essential to day-to-day operations but still provide returns on investment and/or generate income (e.g. Equipment or land that is not currently in use).
Any debts, obligations, or other elements that have a negative impact on your company’s net worth are your balance sheet liabilities. Liabilities are classified under two categories:
Current liabilities: These are short-term debts that can be cleared within the year. Examples of current liabilities include short-term borrowings, accounts payables, revenue due to being received, etc.
Non-current (fixed) liabilities: These are long-term debts that cannot be cleared within the year. Fixed or non-current liabilities are also called long-term liabilities. The list of liabilities on a balance sheet called non-current liabilities includes mortgages taken to build facilities, bonds issued to raise capital, pensions owed, any other loans taken, etc.
Shareholder equity is a quantification of your owner’s stake or interest in the company. You can get your equity value by subtracting liabilities from assets.
Owners’ equity breaks down into three basic categories:
● The initial capital invested by owners
● Additional paid-in capital contributed by owners post initial funding
● Any revenue or business earnings retained and not distributed amongst individual owners
Once you have these components categorized in your sheet you can proceed to use the balance sheet formula to gauge your financial health. The formula is;
Assets =Liabilities + Owners' Equity
Owners' Equity = Assets - Liabilities
Positive equity indicates an excess of assets over liabilities. Negative equity, however, indicates more liabilities than assets, which is never a good sign.
Balance sheet preparation can be approached using a variety of formats. The 4 most commonly used ones include:
In a classified balance sheet format all information regarding assets, liabilities and equity is listed and then sorted (via categorization or aggregation) into accounting subcategories.
This is the most commonly used balance sheet format. Classified balance sheets are useful in managing a large number of accounts and consolidating them in an easy to understand format.
In a common size balance sheet you not only have the same information as the previous format but also an additional column.
In this column the same data is represented as a percent of total assets, in case of assets as line items, or as a percent of all liabilities and shareholders' equity, in case of liability or shareholders' equity as line items. This is a useful balance sheet format for small business because it helps establish trend lines that represent relative size changes for different accounts.
As the name suggests, the comparative balance sheet format uses a linear comparative analysis of all assets, liabilities and shareholders’ equity at different time periods. This too is a useful balance sheet format for small business since it helps analyse company growth trends over a period of time.
With a vertical balance sheet you perform a balance sheet vertical analysis by creating a list that contains total assets, liabilities and shareholders’ equity in one column and then listing, within each, all your line items starting from most liquidable to least.
Balance sheets are amongst the 3 most important financial documents any company must maintain, the other two being Cashflow and Income statements. Not only is it a necessary part of gauging your company’s financial health but it also contributes to other aspects as well. Here’s how:
● Helps stakeholders gain visibility over liquidity position and overall company performance.
● Helps determine periodic growth i.e., company performance trends over a period of time.
● Business loans require you to produce a company balance sheet.
● Helps forecast future performance, guides expansion plans, and helps mitigate future emergencies.
● Helps determine funding channels, capital structure, etc.
Here are 7 simple steps to create a balance sheet that you can follow to make balance sheet preparation easier for your finance team:
Start by gathering any and all documents necessary to creating a balance sheet. This could include all your invoices, financial statements, and transactions carried out in the time period under review. This information is usually found in a company’s general ledger.
Next, choose the date or period of time you wish to review. This date is referred to as a reporting date and is usually the last day of your reporting period.
For companies reporting quarterly, this date will be the last day of each quarter, and for those reporting annually, the reporting date will be December 31st. Companies may also create a monthly balance sheet, in which case the reporting date will be the last day of the month under review.
The next step involves identifying all assets owned by the company up until the reporting date. Assets are listed in balance sheet accounts as individual line items and then as total assets. This helps stakeholders get a better idea of what exactly your assets are and how they were acquired.
Once you’ve listed out all your assets you can then proceed to add them up. Assets are often divided into current and fixed assets. Keep in mind that you must calculate the subtotal of current and fixed assets before you calculate the total of all assets. This can help you identify errors and correct them before they make a botch of your entire balance sheet preparation process.
After listing assets next in line is a list of liabilities on a balance sheet. Follow this step in a similar fashion to how you approached assets, i.e. organize them as both line items and as a total.
Next, calculate the subtotal of all current liabilities (e.g. accounts payables, deferred revenue, short-term debt, etc.) and non-current liabilities (e.g. long-term debt, long-term lease obligations, etc.). Once you have the two subtotals add them up to get your total balance sheet liabilities amount.
Calculating the last component, shareholders’ equity, will depend on whether you are a privately held or publicly traded company. Identify and calculate your shareholders’ equity accordingly. Some common line items in this section include retained earnings, common stock, preferred stock, and treasury stock.
Finally, balance your sheet out by adding total liabilities to shareholders’ equity and comparing the total with total assets. Use the balance sheet formula stated above to calculate this. If, however, your totals do not balance then you need to check your accounting data.
Note that if you’re carrying out these steps for the first time a good practice is to create a trial balance sheet before you start working on your actual balance sheet.
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