How to Create a Balance Sheet for Small Business

Managing and maintaining a company’s financial stability can often be burdensome. Keeping the inflow and outflow of cash in balance, maintaining assets and liabilities, and assuring the company’s financial health is a real challenge that leaves many small business owners perplexed about their company’s financial status. An accurately organized balance sheet can put an end to this perplexity. Creating a clear, comprehensive, and informative balance sheet for small businesses is a common dilemma that many entrepreneurs often face.

But fret not: we’ll guide you through the whole process of creating a balance sheet, simplifying any complexities, and equipping you with all the knowledge and skills that you need to build a strong balance sheet that will help you keep your finances under control. The following paragraphs will break down the complexity by explaining what a balance sheet, its importance, and its vital role is in helping guide your small business toward financial stability and success.

What is a Balance Sheet?

A balance sheet is a financial report that shows a company's financial status at a certain point in time, often at the end of an accounting period, such as a quarter or a year. It is the main financial statement used by companies, investors, and analysts to measure a company's financial health and business performance.

The balance sheet is commonly referred to as the "Statement of Financial Position" because it highlights the company's owns (assets), its owes (liabilities), and the ownership interest (equity) of the owners or shareholders making it essential for Banks and investors to examine the balance sheet to have a better understanding of your company's financial health before investing in it or lending you money.

Importance of Balance Sheet for Small Business

Its value comes from the vital insights it provides and the different ways in which it might help a business. It gives a snapshot of the company's financial health at a certain point in time by indicating if the company has more assets than liabilities, which is a key indication of financial stability. It assists potential investors and lenders in evaluating liquidity, debt management, and tax planning, while building trust. In conclusion, the balance sheet is a critical tool for assessing financial health, making informed decisions, and contributing to a company's overall success and sustainability.

Financial Health Assessment: A balance sheet for a small business helps determine the company’s financial health, so, small business owners and stakeholders can decide whether the company's assets outnumber its liabilities, which is an important measure of financial stability.

Liquidity Management: It assists in evaluating a company's liquidity and keeping the business owner aware of the amount of cash and assets that can be easily converted into cash. Being aware of this information will help you complete your daily operations, pay bills, and seize opportunities.

Debt Management: Small businesses often rely on loans and credit to finance their operations. While a balance sheet shows the scope of a company's liabilities, helping owners in managing and planning for debt repayment.

Investor and Lender Confidence: Investors and lenders usually seek a copy of the company's current balance sheet for the period in order to understand the company's financial status and determine if the company is suitable as an investment choice. So, that’s why a well-organized balance sheet matters.

Track Business Growth: Small business owners can track their company's growth and see how assets and equity have evolved over time by comparing balance sheets from different periods.

Tax Planning: A balance sheet helps with tax preparation by giving information about the company's assets and liabilities. This data can aid in optimizing tax strategies and deductions.

Main Components of Basic Balance Sheet

• Assets: This section lists all the resources and properties that a company owns, including cash, accounts receivable, inventory, real estate, equipment, and investments.

Assets can be further classified as follows:

• Current Assets:

Current assets are assets that can be quickly turned into cash in a year or less. The current assets may include cash, cash equivalents, short-term investments, accounts receivable, inventory, supplies, etc....

• Long-term assets:

Long-term assets are those a company intends to hold for more than a year. These can include:

• Fixed Assets such as Property, Buildings, Land, and Machinery.

• Intangible Assets such as Software, licenses, trademarks, patents, and copyrights.

• Liabilities: Liabilities represent the company's obligations or debts, including accounts payable, loans, and accrued expenses.

Liabilities are further classified into two types:

• Current Liabilities: Under current liabilities come accounts payable, short-term loans, trade payables, and outstanding dues.

• Non-Current Liabilities: Any debts or other financial commitments that can be paid after a year are examples of non-current liabilities such as bonds, long-term debts, debentures, and mortgage loans.

• Equity: Equity, also known as shareholders' equity or owner's equity, is the remaining interest in the assets of the company after deducting its liabilities. It indicates the ownership stake of the company's shareholders.

• Retained earnings

It is the amount of a company's profits that are reinvested in the business rather than distributed to shareholders as dividends.  

• Shareholders' equity

This is the amount of capital that a company receives for its business operations.

 What is the balance sheet equation?

The balance sheet equation, commonly referred to as the balance sheet formula, is a basic accounting concept that shows the connection between a company's assets, liabilities, and equity. It is formatted as follows:

Assets = Liabilities + Equity

This equation assures that a balance sheet is always in balance since assets must equal the total liabilities and equity. A balance sheet is a vital tool for assessing a company's financial health, liquidity, and overall financial performance. It is often included in a company's financial statements, along with the income and cash flow statements, providing an extensive overview of the company's financial status.

Steps to Create a Basic Balance Sheet for Your Business

1. Specify a period/date:

A balance sheet is usually created per specific period, it is commonly created quarterly which is normally due on the last day of March, June, September, and December. Other companies may also do a monthly balance sheet.

2. Collect Financial info: 

Once you’ve set your date, make sure to gather all needed financial data, such as assets, liabilities, transactions, invoices, and financial statements of the company throughout your specified period. It's better to sort them by liquidity. So, start by listing the company’s current assets then include the long-term assets.

3. List the Assets:

List your company's assets in the assets column and don’t forget to include both current and non-current (Long-term) assets. Add up all current and non-current assets under the total assets, compare them with your general ledger, and settle any differences.

4. Determine Liabilities:

List the company's owes (Liabilities) and include both current and calculate the not-current and add it too. Add up the current liabilities subtotal with the long-term liabilities and title it “Total Current Liabilities."

5. Calculate Shareholder’s Equity:

Determining shareholder’s equity in a small business is usually easy because it most likely has a single owner, but it is an essential step to include it. Then add it up with the liabilities and compare it with the assets’ total (Total Liabilities + Total Shareholders’ Equity = Total Assets). 

Note: It’s highly expected that not both sides will equal each other but, in this state, you’ll need to go back to your general ledger and review it

 How to Prepare a Balance Sheet from an Income Statement?

In any business, a balance sheet and an income statement indicate clear financial accounting facts. They both follow the same accounting cycle, starting with the income statement and followed by the balance sheet. The key connection between the two statements is that the profit generated from the income statement is added to the balance sheet as retained earnings to the shareholders' equity.

Balance sheets and income statements are affected whenever a sale or cost is reported. When a company records a new sale, it increases its assets or decreases its liabilities. When a company reports expenses, it results in a decrease in assets or an increase in liabilities.

This demonstrates the close connection between the income statement and the balance sheet. While balance sheets offer a more comprehensive perspective on a business's financial stability and investment health, both documents are essential components of financial statements.

Similarities Between Balance Sheet and Income Statement

The Income Statement and Balance Sheet are both components of the three Basic Financial Statements that every company must have to evaluate their strength. They share several similarities, such as: 

• Accounting Method: They both utilize double-entry bookkeeping to record every business transaction, where each business should have two accounts that record either debits or credits.

• Providing Evidence: The balance sheet and income statement may give proof of the business's financial health, current performance, and continuous growth to investors or lenders to demonstrate that your company is suitable for the required loan.

• Track Business Compliance: Both statements are required to guarantee that businesses adhere to legislative guidelines.

• Financial Reporting:

Both balance sheets and income statements are usually included in a company’s annual reports since they both are the key components of any financial reporting and the main indicators for a business's financial status.

• Reflect Company Performance & Activity:

Both statements hold information about the financial performance and operations of a company. They focus on distinct parts of performance and give different insights, yet both statements convey information about a company's activities. The income statement reflects revenues, expenses, and net income resulting from day-to-day operations, while the balance sheet shows the assets, liabilities, and equity used to conduct those operations.

• Interconnected:

The connection between the balance sheet and the income statement lies in any changes to an income statement item having an impact on the balance sheet. For example, net income from the income statement adds to retained earnings on the balance sheet, while depreciation expenses from the income statement impact the balance sheet value of property, plant, and equipment.

Although they have all the previous similarities, make sure to point out that they serve separate and different distinct purposes. The income statement is concerned with a company's profitability and performance over time, while the balance sheet is a snapshot of a company's financial health at a certain point in time. They provide a full insight into a company's financial situation if utilized together.