Many small business owners find financial reporting daunting. You’re busy running your business, so you don’t have time to spend hours on your finances each week.
Often, entrepreneurs will outsource financial matters to a bookkeeper. Even if you have a subject matter expert reviewing and reconciling your accounts, as a business owner, you should know how to set up – and understand - a balance sheet.
What is a balance sheet?
A balance sheet is a snapshot of the value of your business on a particular date. Your balance sheet shows your business assets (what you own), liabilities (what you owe) and shareholders’ equity (what you have from investors). Understanding what is on a balance sheet and its purpose gives you a view of your business’s overall financial health.
What’s on the balance sheet?
Assets are things of value that your business owns. An asset might be cash or something that you can convert into cash, such as property, vehicles, equipment and stock. There are several smaller accounts under asset management with the common accounts such as:
Cash and equivalents: The most liquid assets which appear on the first line of the balance sheet.
Accounts receivable: This includes the balance of the sales revenue that is still on credit, allowance for doubtful accounts.
Inventory: This account represents the raw materials, and goods to report on sales of goods.
A liability is any financial expense or amount owed by your business. Liabilities include loans, accounts payable, wages, tax and utilities, with the commonly found items are:
Accounts payable: This is the amount of money your business owes suppliers for goods or services purchased on credit.
Deferred tax liability: This includes taxes that have been accrued but will not be paid until the next year.
Current portion of long-term debt: This is the portion due within this year of a piece of debt that has a maturity of more than one year.
3. Shareholders’ Equity
Shareholders’ equity is the amount of money the business owners, or also known as shareholders, have invested into the business. The common components you’re likely to across are:
Share capital: This is the value of funds that shareholders have put into the company investment.
Retained earnings: The amount of money a company decides to keep as net earnings, which could be reinvested and used to pay off debt.
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How do I create a balance sheet?
Xero, one of Australia’s most popular cloud-based accounting software platforms, offers a free balance sheet template that lets you create a balance sheet for your business quickly and easily. Plus, you can easily integrate your Square account with Xero - get started today.
Once you’re across all the key elements and meaning of a balance sheet, follow these steps to set up a balance sheet:
1. Calculate current assets
Once you’ve decided on your reporting date (usually the last day of a quarter), you’ll need to calculate the value of your current assets (cash, accounts receivable, inventory, short-term investments and any expenses you’ve pre-paid) and non-current assets (property, vehicles, equipment or long-term investments), then add these to arrive at your total assets.
2. Identify total liabilities
Similarly, record your current liabilities (credit cards, accounts payable, wages, income tax and short-term loans) and long-term liabilities to identify your total liabilities.
3. Calculate owner’s equity
From here, you need to calculate owner’s equity. If you’re the sole owner of your business, this is generally any investment you’ve made in the business (funding at start-up, for example), plus your drawings and any funds you’ve chosen to reinvest.
Setting up a balance sheet might sound complicated, but most accounting software solutions make it easy to prepare and review your balance sheet. Xero’s free balance sheet template is available to everyone.
Why is it important to keep balance sheets?
Your balance sheet is a snapshot of your business’s financial health at a specific point in time. It can help you to:
Make financially responsible decisions: While many other financial reports provide a historical view of your business’s finances, a balance sheet shows you the financial events that need to occur soon, such as debts that need to be paid during the next period. The information in your balance sheet can also be used to identify financial ratios and trends, allowing you to make informed decisions.
Assess risk and return: Comparing your current assets to your current liabilities shows whether your business can cover its short-term obligations. If your current liabilities exceed your cash balance, you may need to obtain extra working capital.
Secure lending: Your balance sheet lets people outside your business quickly understand its financial position. Most banks and other lenders need a balance sheet before agreeing to extend credit to your business as it will show if you have a track record of managing assets and liabilities responsibly.
As a small business owner, your balance sheet is an important financial statement that you should prepare and review regularly. It should be considered alongside other financial reports, including your profit and loss (P&L) and cash flow statement, for a holistic view of your business’s financial position.
Having a solid understanding of your past, present and future financial position will allow you to assess and improve business performance, minimise your risk and make prudent and realistic plans for growth.