What Is a Balance Sheet?
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A balance sheet shows a company's assets, liabilities and shareholder equity at a single point in time. These financial statements are used to determine a company's health and financial viability at a specific moment in time. A balance sheet doesn't predict future health, but comparing previous balance sheets can provide insight into changes in the company's fortunes.
Assessing the health of a company can be tricky. Luckily, there are financial statements that give investors, shareholders and employees a glimpse at the inner workings of an organization. One of the most important documents, a balance sheet is a snapshot of a company, showing its debts, assets and how much shareholders have invested, all for that specific moment.
How a balance sheet works
A balance sheet is a financial statement that shows a company’s assets, liabilities and shareholder equity at a single point in time. Balance sheets are commonly used to determine a company's health and financial viability. Think of a balance sheet as a thermometer for a business — it gives a picture of the company’s health but only at that moment in time. It doesn’t predict future health, but comparing previous balance sheets can provide insight into changes in the company’s fortunes.
A balance sheet endeavors to solve a basic accounting equation: The value of a company’s assets should equal its liabilities combined with its shareholders’ equity. If the numbers differ, there may be missing information, excessive spending or a lack of profitability of the company’s product or service. The company is failing if the assets are less than the liabilities and shareholders’ equity.
Components of a balance sheet
Any balance sheet has three essential headings: assets, liabilities and shareholders’ equity.
An asset is anything that can be converted to income for the benefit of the company. The most obvious assets are the products or services that the company produces, also referred to as inventory. Other common assets are cash, cash equivalents, accounts receivable and investments.
Assets can be categorized as current or long-term. Current assets can be liquidated within a year, while long-term assets tend to be held longer and can be depreciated or amortized over time. Long-term assets could be real estate, manufacturing equipment, business vehicles or long-term investments. Trademarks and patents are also considered long-term assets.
If an asset is positive, a liability is negative. Liabilities are a company’s debts or money that is owed to others. Liabilities are also broken down into current and long-term liabilities.
Current liabilities could include payroll, rent payments, utilities, taxes and monthly payments on equipment or vehicles.
Long-term liabilities could include business loans, mortgage payments, corporate bonds, pension obligations and any leases that may extend past the current year.
The last component of a balance sheet is shareholders’ equity. Shareholders’ equity is the money the owners or shareholders have invested in the company, plus the amount of money the business makes and any donated capital. It can also be referred to as share capital.
To find the shareholders’ equity, accountants use a simple formula. Shareholder equity equals total assets minus total liabilities. Shareholders’ equity is essentially the same as the company's net assets. If the shareholders’ equity is positive, the company is profitable. If it’s negative, it is failing at that time.
A balance sheet is structured to list assets, liabilities and shareholders’ equity in that order. Within the assets, line items are organized by their level of liquidity, starting with current assets, then long-term assets.
Cash and cash equivalents This is money that is immediately available to use for the business in checking and savings accounts.
Marketable securities This could include stock, commercial paper, Treasury bills and certificates of deposit.
Inventory or accounts receivable Your physical inventory is an asset for companies that make a product. For services, accounts receivable represents the money that the company expects to be paid for work already rendered.
Prepaid expenses If the company’s rent, insurance, marketing or advertising has already been paid, it counts as an asset. They will be marked as a liability if they have not been paid.
Property, Plant and Equipment Referred to in accounting as PP&E, this includes real estate, office equipment, machinery, buildings, furniture and fleet vehicles, among other things.
Intangible assets If the company produces something protected by copyright, trademark or patent, those legal rights are considered assets. These can be hard to quantify and may vary from the actual value, but they should still be accounted for.
Liabilities are also listed in order of emergent need. The payments that are due first will be listed first.
- Short-term loans Loans that will be paid back within the year are considered short-term liabilities.
- Accounts payable Recurring payments could include leases on equipment, materials for production or ongoing expenses like internet service, advertising, etc.
- Accrued expenses Most wages are filed under accrued expenses since they are paid after the work is done.
- Long-term liabilities Any expense with a payment term longer than a year is considered a long-term liability. Pension payments, principal and interest on corporate bonds and mortgage payments would qualify.
The final section of a balance sheet is reserved for Shareholder’s Equity. This section can be broken down into several subcategories.
- Common stock. Common stock is the company’s shareholders' capital investment. If an individual owns it, this would be the money invested by the company owner. For a publicly traded company, it would include the contributions of all equity shareholders.
- Retained Earnings. Retained earnings are the earnings that are not paid out to shareholders in the form of dividends.
- Treasury stock. Treasury stock is stock that the company has purchased back from shareholders. Treasure stock is often kept in reserve for lean times when the company may need to raise funds quickly.
- Preferred Stock. Some companies offer preferred stock as well. Preferred stock doesn’t have a market-based value but offers greater claim to dividends in the event of a liquidation.
- Capital surplus. If shareholders have contributed additional capital beyond common stock or preferred stock, it is considered capital surplus.
Purpose of a balance sheet
Balance sheets show the health and viability of a company at a specific time. The balance sheet of a company can be used to:
- Assess risk If a company is looking for investors, a balance sheet can show how valuable it is at that time and could be in the future. The balance sheet shows how the company needs to operate by showing its debts. Do they need to increase profits or keep more liquid assets?
- Gauge efficiency To run a company efficiently, leadership needs to know how well its resources are being used and how much outlying debt is holding them back. A balance sheet is only one part of this; an income sheet adds more context to the picture.
- Leverage debt If a company is contemplating a significant investment in workforce, equipment or real estate, a balance sheet can show much debt the company currently has. The balance sheet can be used to calculate the debt-to-equity ratio, an essential metric for determining the risk of taking on new debt.
- Uncover errors If the balance sheet doesn’t balance, it could be because some information is missing or incorrect. Finding the missing components can help accountants and bookkeepers ensure that all reporting is completed accurately.
Who needs a balance sheet?
Balance sheets are valuable tools for any business owner, but they are required of publicly traded companies. C-corporations with receipts and assets of more than $250,000 must submit a balance sheet with their taxes and make sure it aligns with the balance sheet included with Form 1120.
Smaller corporations are not required to submit a balance sheet with their taxes, but their shareholders and current and potential employees may still ask for one to assess the company's health.
Who prepares a balance sheet?
Balance sheets, income statements, cash flow statements and owner’s equity statements are four essential financial statements. A company’s accountant typically prepares them. A bookkeeper or the company owner may prepare the balance sheet in small companies.
Timing of balance sheets
As mentioned above, a balance sheet only shows the worth and health of a company at that exact moment. For this reason, many companies complete balance sheets several times throughout the year. Used together with an income statement, periodic balance sheets can show how a company is growing or slowing down. Most companies complete balance sheets on a set schedule, whether monthly, quarterly or annually.
Who looks at a balance sheet?
Outside of a company's leadership, a balance sheet is a helpful tool for many interested parties. Lenders may require a balance sheet when assessing creditworthiness, and some small business loans, such as the SBA 7(a), require a balance sheet when requesting more than $350,000. Nonprofits applying for grants may also be asked to provide a balance sheet.
If a company is up for sale, potential buyers may ask to see a balance sheet to see if the net assets are robust enough to merit a purchase. Potential employees may also look at it to see if the company is a good long-term fit for their career goals.
Limitations of a balance sheet
Although balance sheets can offer a snapshot of a company, an accurate picture of its health requires more movement. This is why balance statements are often paired with income statements and cash flow statements to create a more comprehensive analysis of its viability.
Even if a company completes balance statements on a monthly basis, weekly surges in expenses may create undue stress on its resource. Similarly, if there is a chance of some accounts receivables being delayed or forfeited, a company may find its balance sheet out of balance for a time.
Another limitation is the assessment of the value of intangible assets. In cases of patents and trademarks, values may be over or under-assessed, creating a false value that is offset by actual liabilities.
Balance sheet key takeaways
- A balance sheet can help owners and shareholders know if their company is successful, if it’s being managed well and if changes need to be made.
- If a company is making chairs and their expenses for wood go up over the course of a quarter, but the price of the chairs remains the same, their balance sheet would show the discrepancy.
- A balance sheet offers a temperature gauge of your company's health, one reporting period at a time.