What Is a Balance Sheet: Definition, Purpose, Formula and Examples

Financial statements help owners better manage their businesses and secure working capital from lenders or investors. While there are several types of financial statements that are useful to businesses, the balance sheet is one of the most important.

But what is a business balance sheet? Why is it important, and what does it include? Let’s take a closer look at balance sheets and why your business needs them.

A balance sheet is a financial statement that details a company’s:

• Assets
• Liabilities
• Shareholder/owner equity

Balance sheets are used to calculate the rate of return for investors and to analyze a company’s capital structure.

Typically, balance sheets are used with other financial statements to calculate financial ratios or perform fundamental analyses.

When is the balance sheet prepared?

In most cases, balance sheets are prepared at the end of an accounting period, such as:

• The end of the month
• The end of the quarter
• The end of the year

However, balance sheets can be prepared whenever a business needs to show its financial position.

A balance sheet is important for businesses of all sizes because it helps owners monitor the financial health of their businesses. Business owners can use cash flow statements and balance sheets to make more informed and strategic decisions.

Balance sheets can also help:

Evaluate Risk and Return

A balance sheet helps put your business’s financial health into perspective. Your assets give you an idea of your ability to sustain operations or generate cash. Your liabilities, or debts, help you prioritize where your cash is going.

For most businesses, the goal is to have more assets than liabilities. However, having more liabilities than assets indicates that you will need additional working capital either through loans or investors. In some cases, your liabilities may far exceed your assets to the point where the business would become unsustainable.

Having this information on-hand allows you to evaluate risk and return, helping you make better business decisions.

Attract Investors and Secure Loans

If you need to secure working capital via a loan or through investors, then you’ll need to have a balance sheet prepared.

Your balance sheet will help investors and lenders understand your business’s financial position.

Most lenders will require you to have a balance sheet to determine your creditworthiness. It can demonstrate your ability to repay your debts, and it can also help investors understand where funding will go.

Make Tax Preparation Easier

Balance sheets can also make tax preparation easier for your accountant or tax preparer. Having organized and updated financial records is important when running any business. Balance sheets will also ensure that your business is better prepared if the IRS does audit you.

There are many types of financial statements that businesses should prepare and maintain.

Cash Flow Statement

A cash flow statement outlines how much money is coming into and out of your business. It gives you an idea of how much working capital you have at a specific period in time.

Income Statement

An income statement is also known as a profit and loss statement. It shows a business’s incoming cash and outgoing expenses over a specific period of time.

Income statements take your revenue, expenses and losses into account, helping you better determine whether your operations are turning a profit or losing money.

Balance Sheet

A balance sheet, as you now know, highlights three key things:

• Your assets
• Your liabilities
• Your equity

It can help you understand whether your business is in a position to meet its financial obligations.

Statement Of Owner's Equity

A statement of owner’s equity is a report that shows the difference between a business’s total liabilities and total assets, which indicates the value of the owner’s equity.

A good balance sheet can help a business make informed decisions. In addition, it's used to help ensure that a business isn’t taking on too much debt and can meet its financial obligations.

It’s also used to help businesses secure loans or investors.

Now that you know what a balance sheet is and why it’s important, you may be wondering: what is reported on a balance sheet?

Components Of a Balance Sheet

A balance sheet has three main components: assets, liabilities and owner’s equity.

Assets

An asset is anything owned by the company or held by the business that’s of value. Theoretically, the business could turn around and sell its assets for cash through liquidation.

Assets can include but are not limited to:

• Cash and equivalents
• Inventory
• Prepaid expenses
• Accounts receivable
• Marketable securities
• Patents and trademarks
• Intellectual property
• Equipment
• Real estate

Liabilities

Liabilities are what the company owes. These are debts and other financial obligations that a business incurs.

Liabilities can include but are not limited to:

• Payroll expenses
• Debt financing
• Rent and utility payments
• Accounts payable
• Loans and leases
• Deferred tax liabilities
• Bonds payable

Owner’s Equity

Owner’s equity is anything owned by the business owners after accounting for liabilities. It is the amount leftover when subtracting liabilities from assets.

What Is Not Reflected in the Balance Sheet?

There are some things that are not reflected on a balance sheet that are still important for owners to monitor.

Some things you likely won’t find on your balance sheets include:

• Intangible assets, like accumulated goodwill
• The value of your teams
• Depreciation
• The fair market value of your assets
• Amortization

Financial statements are only useful if you know how to analyze them. It’s important to know how to understand a balance sheet and how to project a balance sheet.

The main technique used to analyze a balance sheet is ratios, such as:

• Debt-to-equity ratio
• Solvency ratios
• Liquidity ratios
• Activity ratios

Solvency and liquidity ratios show a business’s ability to meet its obligations. Financial strength ratios can help investors determine whether the business is financially stable and how it can finance itself.

Activity ratios can also help you better understand how well you are managing your operating cycle and the efficiency of your operations.

Your company's balance sheet gives you an overview of your assets and liabilities as well as how they relate to each other. You can use the data on your balance sheet to determine whether:

• Your business can meet its financial obligations
• Whether your company has a positive net worth

Your balance sheet can help you determine whether you need to make changes to improve your business’s performance or whether you’re on the right track to meet your goals.

A balance sheet is just one piece of the puzzle when it comes to managing your business’s finances. Cash flow statements are equally important and are often used alongside balance sheets when making decisions.

But calculating your cash flow isn’t easy, especially if you do it manually using spreadsheets.

Cash Flow Frog makes it easy to manage your cash flow by allowing you to create cash flow forecasts, projections, what-if scenarios and more in seconds. Just connect your accounting software to your Cash Flow Frog account and you’re ready to start managing your cash flow. It’s that simple, and you can start today for free.