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Learn about balance sheets and how they differ from other financial statements.
A balance sheet is an essential tool for business owners who must understand their assets, liabilities and owner’s equity and how these balances change from one accounting period to the next. This guide introduces you to the balance sheet and explains its importance to your business.
A balance sheet lists assets and liabilities and the difference between them (owner’s equity) at a specific time. The balance sheet helps you analyze your business’s financial health and net worth according to book value.
A balance sheet includes the following:
Here’s a look at each component.
Assets
There are two types of assets: current assets and noncurrent assets:
Liabilities
Business liabilities are financial obligations a company owes other entities. They are categorized into current and long-term liabilities:
Owner’s equity
The difference between total assets and total liabilities equals owner’s equity (or shareholder’s equity). If the business assets are greater than its liabilities, the owner’s equity is positive. If the liabilities exceed the assets, the owner’s equity is negative.
A balance sheet is one of three financial statements. The other statements are as follows:
Consider balance sheets for the beginning and end of a financial period as snapshots in time. The income statement shows what happened during that time. The cash flow statement ties the balance sheets and the income statement together by showing how cash moved in and out of the business.
A balance sheet is a snapshot of your business’s health at a specific time. You need balance sheets for the following reasons.
You should compare balance sheets from the beginning and end of a specific period to see how the total amounts change. For example, your balance sheet tells you how your assets compare to your liabilities. If your short-term liabilities (amounts you must pay within the next financial period) are growing in proportion to your short-term assets, such as cash, you may have trouble meeting obligations in the near future.
You’ll need to present financial statements, including balance sheets, to bankers and other outside parties. For example, if you apply for a business loan, the bank will expect to see your financial statements to determine your business’s financial health.
Unless you file taxes as a sole proprietor, you are required to have a balance sheet for tax purposes. This balance sheet may differ from the one you use for accounting purposes, for example, if you use a different accounting method for tax vs. book depreciation.
If you ever want to sell the business, you should be able to say what the book value of your company is according to the balance sheet.
However, business valuation is complex. Book value does not take into consideration future expectations for a company. For example, a company that is growing and making a profit should be worth more than the book value in a sale. Meanwhile, a business that is struggling or has recently received negative press may sell for less than the net book value, as shown on the balance sheet.
William Brigham, director of the New York State Small Business Development Center in Albany, New York, said a balance sheet is a good reality check when it comes to determining your business’s value. “Everybody thinks their business is worth more than it really is,” Brigham explained.
Balance sheets provide crucial visibility into the financial health of your business. They help you compare revenue and expenses side by side, tracking where your money comes in from and where it goes. Balance sheet insights can enable better decision-making, more accurate financial planning and improved forecasting for your business ― all of which can contribute to your success.
Adam Uzialko contributed to this article. Source interviews were conducted for a previous version of this article.