There are three main financial statements that businesses create and use: the balance sheet, the income statement, and the cash flow statement. They provide information to finance companies, banks, and other vendors about the financial stability of a company. Creditors often request these financial statements when approving loans or vendor accounts. Businesses can also use them internally for reporting and trend spotting.
We’re going to look at what a balance sheet is, what information is included in it, how to prepare it, and how to analyze this document to help make business decisions. We’ve also included examples from other companies, and a simple template you can use to make your own.
What is a balance sheet?
A balance sheet is a snapshot of a business’ financial standing at a certain point in time, providing a static look at the assets and liabilities of a company on a certain date. It is also known as a statement of financial position.
It’s called a balance sheet because the account totals need to balance. The report is based on the basic accounting equation that says assets equal liabilities plus equity. This makes sense, because in order for a company to purchase something (i.e. an asset), they have to either incur a liability or invest in the company to fund the purchase.
What is included on a balance sheet?
A balance sheet includes three main kinds of accounts from the general ledger: assets, liabilities, and equity accounts.
Assets and liabilities are further broken down into two categories: current and long-term. “Current” generally describes an asset or liability that can be liquefied (converted into cash) or paid within 90 days. “Long-term” assets and liabilities take longer than 90 days to liquefy or pay.
Assets include bank accounts, certificates of deposit, accounts receivable, fixed assets (equipment, vehicles, buildings, etc.), and inventory.
Liabilities include accounts payable, loans, notes payable, and payroll accruals (like vacation/sick time and benefits).
Equity accounts show investments from owners and stockholders. Accounts include retained earnings (a carryover from profit from prior years), stock shares, and shareholder investments.
The account balance for each item on the chart of accounts is included in the balance sheet report.
Why does a balance sheet matter?
The balance sheet is one of the primary financial statements that are used to assess a company’s financial standing, along with the income statement and cash flow statement. The balance sheet is the only one of the three that’s for a specific date, while the other two report on transactions that take place over a period of time. Customers and vendors use these documents to assess a company’s financial health and determine whether they want to work with them.
Several financial key performance indicators (KPIs) and ratios can be calculated based on the values in the balance sheet.
These calculations help companies determine their financial status. If certain ratios are out of sync, a company can make changes to help improve them. Ratios like working capital and debt-to-equity ratio let vendors know if companies can afford to pay their bills. They use this information to extend credit to customers and to make internal business decisions.
Surety companies also use information from this and other financial statements to make decisions on bonding capacity for construction companies and others that need to provide bonds. Sureties look for companies with a positive net worth and enough cash to cover their current expenses.
How to prepare a balance sheet
While most accounting software packages will prepare financial statements at the click of a button, it’s always good to know where the information comes from. Because the balance sheet is a snapshot of a company’s financial status at a specific date, the structure for the report comes from the company’s general ledger and chart of accounts.
Here are three steps for preparing your balance sheet:
- Start by listing each account from the chart of accounts in the order of assets, liabilities, and equity accounts. Not all the accounts on the chart will be used, as income and expense accounts are only used in the income statement.
- Once the accounts are listed, enter the balance of each account at the end of the time period you’re looking at.
- After listing all the balances, you’ll want to confirm that the balance sheet balances. Add up the liabilities and equity accounts, and the total should match total assets. If it doesn’t, you’ll need to review your account balances and transactions to make sure your information is accurate.
Download a free template
Get a balance sheet template to use in Google Sheets or Excel.
Balance sheet examples
Many companies publish a balance sheet in their annual report. Here are two examples of balance sheets from companies in the construction industry. You’ll notice that the total assets amount matches the total liabilities plus equity.
How to read a balance sheet to make business decisions
Overall, a balance sheet shows you how much cash a company has, how much they owe, and how much they’ve invested in the company. When reviewing your own balance sheet, you should look at it like a potential customer. Review several reports over time to get more insight — this will help you know what you need to improve in the future.
Here are some things you can discover by reviewing the balance sheet:
- How much debt you have relative to equity
- How quickly customers pay their bills
- Whether cash levels are declining or increasing
- How many days it takes to sell inventory
- Whether profits are being spent or reinvested
Once you’ve completed your analysis, you can begin to make changes in your business to affect your financial position. These changes can include investing profits back into the company, reallocating assets, and changing inventory levels.
For example, if you find that you have a high level of accounts receivable and aren’t collecting payments within your credit terms, you can change things to improve your collections.
In the construction industry, this includes sending preliminary notices and filing mechanics liens when necessary. Companies in other industries may create clearer payment terms, follow through with collection policies, and provide customers payment flexibility when needed.
Take your company’s temperature with financial statements
Financial statements like the balance sheet give business owners insight into how their business is doing financially. Income and expenses aren’t the only things that need to be tracked.
The balance sheet shows a snapshot picture of a company at a point in time. It lists its assets and liabilities, as well as the amount that has been invested. Reviewing the report regularly and comparing it to prior periods allows management to spot trends and make changes in their business.