What is a Balance Sheet?
Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
A balance sheet provides a snapshot of your company’s financial position at any given time. It is commonly used as the basis of other financial ratios that analysts will use to ascertain the financial health of your business. It provides an overview of your assets (what you own), your liabilities (what you owe) and your shareholder equity (essentially your company’s net worth).
Along with income and cash flow statements, it is one of the three core financial statements used to gauge your company’s financial wellbeing. Using this, analysts can determine your debt-to-equity ratio and whether your short-term assets can cover your immediate liabilities – known as the ‘acid test’ ratio.
What should I include on my balance sheet?
A good example of a balance sheet will include the following core components:
A company’s assets include:
- fixed assets like property, machinery and vehicles
- accounts receivable (monies owed to you)
- liquid assets like equity and debt securities
- current assets like inventory
- intangible assets like your Intellectual Property
A company’s total liabilities will need to encompass both current liabilities (short-term debts) and long-term liabilities. Current liabilities may include:
- wages payable
- customer prepayments
- interest payable
- bank debts
Long-term liabilities, on the other hand, may include:
- deferred tax liability (such as ‘time to pay’ arrangements with HMRC)
- pension liability
- principal and interest on bonds issued by the company
Shareholder equity, or net assets, refers to all funds attributable to the company’s owners or shareholders. This is calculated by taking stock of the company’s total assets and deducting all liabilities and debts owed to non-shareholders. Learn more about managing your business cash flow.
Why should I use a balance sheet?
Balance sheets are typically used by analysts and prospective investors to calculate a company’s net worth. But even if your business is unincorporated, it’s still a good idea to use a balance sheet to improve visibility when it comes to your business finances. Larger, publicly owned companies are legally required to make their balance sheets visible. This means they are much more likely to use an outsourced accountant that can handle an enterprise-level balance sheet.
A balance sheet can help you to better understand:
- the net worth of your business (whether positive or negative)
- whether you have enough short-term or current assets to cover your immediate liabilities
- how your debts and net income compare to those of your competitors
Your balance sheet will also play an important role in your reporting to HMRC. Find out more about financial analysis.
Frequently asked questions about balance sheets
Who is responsible for preparing my balance sheet?
The parties responsible for preparing your balance sheet will likely depend on the size of your business. In the case of small businesses, it’s not uncommon for the business owner or in-house bookkeeper to prepare this financial statement.
Medium-sized businesses may prepare their balance sheet in-house before sending it away to an outsourced accountant to review.
What are the limitations of a balance sheet?
A balance sheet provides an overview of your company’s assets, liabilities and equity. As such, it is extremely useful for business owners, investors and analysts alike. However, by definition, it can only provide a snapshot of your company finances. It cannot track improvements in the company’s financial health compared to previous years or be used to make predictions for the future.
This is why a balance sheet will usually be paired with an income statement and cash flow statement. These provide a more balanced view of the company’s financial wellbeing and its trajectory.
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