What Is a Balance Sheet? FAQ
What Balance Sheets Are, and Why They Are Important to Entrepreneurs
Dec 15, 2007
A balance sheet offers an aerial view of a specific business' financial status at any given moment, although it is usually only used at the end of an accounting cycle such as a month, quarter or year. This may sound similar to an income statement, but where it differs is in the details: a balance sheet is filled with the details of a business' assets, liabilities and equity, whereas an income statement focuses on the profits and losses.
Both the assets and liabilities in a balance sheet are divided up by their term - short or long term - such as checking or government securities. As well, the assets listed in a balance sheet must at all times equal the amount of liabilities plus the equity held in the business in order to be considered valid.
How Can an Entrepreneur Use a Balance Sheet?
Balance sheets are used by entrepreneurs to determine whether or not the business is in a strong position to grow and/or evolve financially. For instance, the balance sheet should easily show whether or not an entrepreneur can afford to take risks financially because they've padded themselves adequately for the normal ups and downs of running a business, or if measures to safeguard the financial security of the business would be more prudent.
Balance sheets also show trends in payables and receivables, and what, in turn, should be focused upon. A business with a long payment cycle may look at its balance statement and see how things could be tweaked, or it may notice that the payables have slowed down in frequency in order to deal with a potential cash shortage.
Why Are Balance Statements Important to Entrepreneurs?
Balance sheets, in tandem with income statements, are the most important records in an entrepreneur's financial reporting system, and therefore are required by law in many countries. Most lenders, investors and/or vendors will need to see a business' balance statement before making a decision regarding credit and equity.
What Is in a Balance Sheet?
The following items comprise a balance sheet:
- Assets Assets in a balance sheet are divided into two categories - long and short term - depending on the length of time required to liquidate them (meaning: turn them from assets into cash). Therefore, cash is the most liquid of all assets, whereas items like stock and machinery are less liquid.
- Current Assets Current assets include any items that can be liquidated into cash within a calendar year. These include:
- Cash, including checking accounts, are the most liquid of all assets.
- Accounts receivable are also highly liquid, although they make take a bit longer to receive depending on the payment cycles the business has requested from its clients, and include any monies owed to the business by suppliers or customers through purchases made.
- Notes receivable are also considered liquid, but if they are not receivable within the year, they are to be bumped into the long-term asset category.
- Fixed Assets Fixed assets include:
- Land is a fixed asset, but unlike the others in this list is not considered depreciable because it does not lose value over time or wear out.
- Buildings
- Office equipment such as fax machines, telephones and computers used to run the business.
- Machinery used to produce products to sell for profit are also added to the fixed assets list.
- If there are vehicles used in business operations, they are added here.
- Total Assets All of the fixed assets are then totaled together, minus any depreciation.
- Liabilities and Owner's Equity This part of the balance sheet may be named liabilities, or liabilities and owner's equity, depending on the person creating the chart, and include all debts the business owes to suppliers, vendors or creditors, such as:
- Accounts payable
- Notes payable
- Accrued payroll and withholding
- Total current liabilities
- Long-term liabilities
- Mortgage note payable
- Owners equity
- Common stock
- Retained earnings
- Total Liabilities and Owner's Equity All of the liabilities and owner's equity are totaled together, and should equal the amount of assets if calculated correctly.
Want to see what a complete business plan looks like? Then review our Free Business Plan Templates and More Free Business Plan Templates. Or, go back to the Free Business Plan How To.
