How to Prepare a Balance Sheet for Accounting

Oliver
Oliver August 2020 6 min

Before we dive into the details, what is a balance sheet? Well, the alternative name of a statement of financial position may go some way to explaining it.

Simply put, a balance sheet is a snapshot of a companies financial situation at a specific time. Two other core financial statements, the income statement and the statement of cash flows, are used with the balance sheet to assess a business financially.

Analyzing a companies financial position is fundamental to its efficient and secure running, and the balance sheet is one of the main tools to achieve this. 

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What is on a Balance sheet?

In essence, a balance sheet shows everything a company owns and everything it owes to creditors. In financial terms, it includes all assets, liabilities, plus shareholder and owner equity.

The companies assets and liabilities are further split into long- and short-term. Once completed, the company’s assets must equal its liabilities, plus owners’ equity. 

Preparing

Your balance sheet will comprise the three elements mentioned above; assets, liabilities, and equity, and follows the basic accounting rule;

Assets = Liabilities + Equity

Following the accounting equation, assets are shown on the left with liabilities and equity on the right. A balance sheet can be created for any length of time, but it often covers a twelve-month period.

Items are listed in order of liquidity, with cash and inventory first. Items that are more difficult to liquidate, such as real estate and equipment, appear further down.

Line-items are added for each type of asset or liability. When the totals are calculated at the bottom of the sheet, they will balance. If not, there is a mistake that needs to be rectified.

What the balance sheet gives you is a statement of the business’s financial situation at that moment. For a business, it is an essential tool. The Penta Business Banking Solution offers a variety of ways to keep you on top of your company finances, and makes producing a balance sheet simpler.

Balance Sheet Items in Detail

Let’s take a closer look at the three items that make up a balance sheet; assets, liabilities, and equity.

Assets

An asset from an accounting point of view is anything a business owns that can be expressed as a monetary value. Some examples include;

  • Cash – both cash in hand and bank balances
  • Accounts Receivable – money owing to the business
  • Inventory – stock items ready to sell or parts to be used in producing stock
  • Real Estate
  • Equipment and machinery
  • Vehicles

Assets may be categorized on your balance sheet by order of liquidity, with cash at the top and long-term assets at the bottom.

Liabilities

From an accounting point of view, liabilities are everything a business owes to creditors. They appear on the right of the balance sheet, indicating a claim against the business’s assets. Keeping control of your business expenses is vital. Open a Penta Business Account and it includes Penta expense management to simplify and automate your business payments.

Liabilities include;

  • Salaries and wages
  • Accounts payable – money owed to suppliers and other creditors
  • Taxes payable – VAT or sales tax for example
  • Interest payable
  • Dividends due – shareholder dividends
  • Long-term debt
  • Pension fund

Some liabilities are classified as long-term and appear at the bottom of the balance sheet, including business loans, for example.

Equity or Capital

There are two forms of equity, owners, and shareholders. A business that operates under sole proprietorship rules has only owners equity. When your business has investors, then there is also shareholder equity.

What can a Balance Sheet Show You?

A balance sheet is a handy document that can be used anytime to assess the business’ financial situation. When preparing a company’s annual return, an accountant will also provide a balance sheet. With Penta’s built in automated accounting functions, you will always be on top of your accounts.

Your company’s balance sheet gives you valuable financial information, and it is worth taking the time to understand the details.

Liquidity

When your company liabilities outweigh the assets, the company’s cash flow cannot cover its financial commitments. This is a precarious situation that may require an injection of cash, either from shareholders or via a loan.

The balance sheet lists the most liquid assets at the top, so it is easy to identify those that can be quickly converted to cash if needed.

Return on Investment

A company with shareholders must provide a return on their investment. Using the figures provided on your balance sheet, you can also show potential investors that your company is a sound investment.

There are several calculations you can make using the figures on your balance sheet, such as;

  • Return on Invested Income (ROIC)
  • Return on Equity (ROE)
  • Return on Assets (ROA)

These are figures that your accountant should provide you along with the balance sheet.

Limitations

A balance sheet does have a couple of drawbacks, so it should always be used in conjunction with other financial statements. Specifically;

  • It is a static snapshot, which means it compares one point of time in the past with the time the balance sheet was completed.
  • How depreciation and inventories are accounted for can alter the figures shown on a balance sheet. When using this to decide whether a company is a good investment, check the footnotes to determine how the figures are calculated. If in doubt, check with a qualified accountant.

Why use a Balance Sheet

A balance sheet is an essential tool in understanding the financial situation of a business. Many companies will produce multiple balance sheets to compare recent history or financial performance over the past few years.

Successful companies set themselves annual goals, and producing a yearly balance sheet gives you detailed information on performance against targets. No matter if you are a freelancer, a small SME or large corporation, balance sheets are an important tool for controlling your business.

Final Thoughts

Many will think a balance sheet is something only your accountant uses, but it’s an essential tool to monitor your business. Learning how to produce one, and importantly, how to interpret it will quickly pay back the cost in time.

Built into the Penta Business Account are sub-accounts, that allow you to put aside funds for tax payments, investments or projects. They’re a great way of controlling your business funds and making sure you can pay your liabilities on time.

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