A balance sheet is an important financial statement for every business, and it’s essential that business owners understand what goes into a balance sheet, and what it can tell you about the financial health of your business.
1) What a Balance Sheet is All About
A balance sheet is a statement of a business’s assets, liabilities, and owner’s equity. Typically, a balance sheet is prepared at the end of a pre-determined period, such as every month, quarter, or year. A balance sheet comprises two columns. The column on the left lists the assets of the company, and the column on the right lists the liabilities and owner’s equity. The total of liability and owner’s equity should equal the total assets. For example, a business owner starts up his/her company with $1,000 in cash. This means the company has assets of $1,000, no liabilities, and owner’s equity of $1,000 (the original owner’s contribution to the business). In this example, the two columns balance out equally.
2) Debt Ratio
The balance sheet offers a glimpse into how a company is doing financially, and one of the key indices is the debt ratio, which is derived by comparing total debts to total assets. More precisely, total liabilities are divided by total assets to obtain a percentage. For example, if a company has assets of $100,000 and debts of $55,000, the debt ratio is 55% ($55,000$100,000). The goal is obviously for the company’s assets to be able to cover debts, and it’s not advisable to have too much debt as compared to your company’s assets. The larger the percentage (the debt ratio), the more the company is leveraged. A larger debt ratio can present big problems when a company is too heavily leveraged. Acceptable debt ratios vary by industry.
3) Owner’s Equity
In the broadest terms, owner’s equity is what would be left for owners from company assets after paying off all liabilities, or the total amount you have invested in the business. For a sole proprietorship, equity represents the owner’s investment in the business (cash and property put into the business) minus any withdrawals. If owner’s equity declines, it’s important to review what’s going on and make necessary changes, such as paying off debts and reducing liabilities. On the other hand, if owner’s equity is increasing, you’re doing something right!
4) Who Looks at the Balance Sheet
The balance sheet is an important clue for a business owner about how his or her company is doing financially. But owners aren’t the only people looking at balance sheets. Lenders typically look at this financial statement as well. For example, when applying for an SBA 7(a) loan over $350,000, a balance sheet is required. And, should you put your company up for sale, potential buyers also look at a balance sheet to assess the company’s financial position.
5) The Balance Sheet and Tax Reporting
For federal income tax purposes, only C corporations are required to complete a balance sheet as part of their annual return. This balance sheet compares items at the beginning of the year with items at the end of the year. The IRS wants to see that the balance sheet included with Form 1120 agrees with the corporation’s books and records. However, small corporations – those with total receipts and total assets less than $250,000 at the end of the year – are not required to complete the balance sheet for the tax return.
Needless to say, you don’t have to be an accountant or great with numbers to create a balance sheet for your business. You can use any number of free templates to create your own balance sheet, and most accounting tools can automatically prepare one for you based on information you provide.
(Reprinted with permission from NADCA.com)
