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What is a Balance Sheet? Everything Business Owners Need to Know

By September 2, 2021 No Comments

balance sheetThe balance sheet is a snapshot or moment in time. If you own a business, you’re probably at least somewhat familiar with the term balance sheet. If it feels like a foreign term, the first thing you need to know is that it is comprised of three main sections: assets, liabilities, and equity.

When combined with the income statement and cash flow statement, the balance sheet—and subsequent understanding of it—is integral for owners, shareholders, and even potential investors.

On the Balance Sheet: Assets, Liabilities & Equity 

Assets are listed before liabilities, and they typically are listed from most liquid to at least liquid. That means the first item on the balance sheet will be the most liquid, i.e. cash. As you move down the list of assets, you’ll find accounts receivable because you can usually turn accounts receivable into cash within 30 days. After that, for some companies, it might be inventory—this turns into cash after about 90 days. The final items listed would be property and equipment, as they are difficult to liquidate. 

Why care about some of these items? Take accounts receivable, besides knowing how much customers owe you, it is where you can create liquidity. Typically you can establish a line of credit based on your current receivables. The rule of thumb is that you can borrow against 75% of accounts receivable. This is really important as a mechanism for enabling your growth—and it’s why you’ll really need to care about some of these balance sheet line items.

Liabilities are listed in a similar way: from the most likely you will need to pay. The first liability is accounts payable—items that typically will be paid in the next 30 days. You might see a credit card liability or a payroll liability after accounts payable. Further down on the liabilities list, you’ll get into things like a loan that may be due over a five year period.

Finally, in the equity section, you’ll see a couple of things depending on the type of business you own. The equity “blob” or “plug” is basically just assets minus liabilities. It does not equate to what your business is valued at; it’s more of a catch-all that’s specific to your business at a given point in time. You might see what’s been contributed by the owners, what’s been withdrawn by the owners, and how much the business has made over time. Those are the three components most equity items boil down to. 

Balance Sheet FAQs

You asked, we answered. To recap, here’s a quick rundown of everything balance sheet

What is a balance sheet?

A balance sheet is a financial statement that encompasses assets, liabilities, and equity. We like to think of them as a “snapshot in time” that paints a picture of where you are from a financial health perspective. 

What does a balance sheet show?

A balance sheet lists assets first and then liabilities. They typically go from most liquid to at least liquid. It shows a snapshot of the business at a specific point in time.  

How to read a balance sheet?

Your balance sheet is essentially written in the language of business so that people can easily understand where you are from a financial perspective. 

Having a common format allows for greater understanding. It’s a very logical way to do things because it answers questions like, “What do I have to spend right now?” which comes in handy before you spend money on, let’s say, a long-term asset. 

How to make a balance sheet?

The best way to make a balance sheet is to use accounting software, like Xero or QuickBooks, as these programs generate balance sheets for you automatically!

How to calculate net income from a balance sheet?

Net income is not calculated from a balance sheet but rather from your income statement. Net income then transfers over into the equity section on your balance sheet to make everything work and balance out, so to speak.

What are retained earnings on a balance sheet?

Retained earnings are essentially the cumulative impact of the income statement on the company. To learn how to calculate retained earnings on a balance sheet, again, using software is your best bet. 

What is goodwill on a balance sheet?

Goodwill is a category of assets that occurs when a business is acquired. 

When you do an acquisition, you put all the assets that you bought on your balance sheet as well as the liabilities.“Typically, you paid more than that—which is a good thing, because most of the value of companies comes from these intangible assets, like their customer relationships, their employees, their intellectual property. It’s not stuff that you can tangibly apply generally. So most smaller companies call that all goodwill.

Balance sheet vs. income statement: How are they different?

Again, a balance sheet is a moment in time that shows where your financial health stands. Income statements, on the other hand, are more like financial scorecards. They encompass how you did this month, or how you did this quarter, or how you did this year.

At the end of the day, knowing how to read and understand your balance sheet can provide valuable insight into the financial health of your business. By taking the time to learn and comprehend the value of each component, you’re now one step closer to financial success. Schedule a call with our team to explore our service offerings and find out how Acuity can best serve your business.