What is a Balance Sheet? According to Chartered Accountant, Financial Analyst and Consultant, Mrs. Ngozi Amaefuna, a balance Sheet is a record of the liabilities (what the business is owing, where the money is being spent) and the assets (what the business is being owed, where the money coming from). The word ‘balance’ indicates that ... Continue Reading
What is a Balance Sheet?
According to Chartered Accountant, Financial Analyst and Consultant, Mrs. Ngozi Amaefuna
, a balance Sheet is a record of the liabilities
(what the business is owing, where the money is being spent) and the assets
(what the business is being owed, where the money coming from). The word ‘balance’ indicates that the two sides of the account must always balance, since the money raised as capital (usually a sum of the liabilities and owners’ equity) must have been used for some purpose and must be accounted for.
It is a statement of a firm’s assets, liabilities
and owners’ equity at a specific date (i.e. it is a “snapshot” of the financial strength of a business at a particular moment in time). The balance sheet summarizes the financial state and position of the business to date. The liabilities and owners’ equity (proprietary interests, shares and monetary commitments) usually represent the sources of the capital and tell us where the money came from whereas the assets
represent the uses of the capital and tells us how the money gotten was spent.
What are some of the advantages of balance sheet to your business?
Even though, a balance sheet may not be formally required for most small business reports or even taxes, it can be extremely helpful in determining the overall health of a company or business. Without an understanding of basic accounting principles, it may be overwhelming to think of creating a balance sheet or any other financial report.
However, balance sheets can be quite simple for a small business owner to create and can even be generated automatically by most online or traditional accounting software. This is the reason why as a business owner, investing in your financial education does immeasurable good to your business. Having a basic knowledge and understanding of accounting and book keeping terminologies helps you run your business strategically rather than haphazardly.
In a rundown, let us take a glance at some of the benefits of a balance sheet to your business.
1. It shows at a glance the financial position and state of a particular business.
2. It shows the liquidity of the business (how much assets
can be easily turned to cash to take care of liabilities
3. It shows the owners’ proprietary interests and monetary commitment (in terms of capital) to the business.
4. It discloses the asset
strength of the business and cash flow index.
6. It tells you how money is coming in and how it’s leaving your business.
7. It helps to ascertain the amount of capital that has been employed in the business.
9. It also serves as an aid in the termination of various ratios which help in better management of the business.
10. It also serves as an invaluable source of information as to the future prospects of the business.
Let’s explain some these great merits of balance sheet further
As a small business owner, the balance sheet gives you your business snapshot. When you own a business, you can usually turn to either your balance sheet or profit and loss statement to understand how your business is doing financially. While your profit and loss statement can quickly show your expenses versus your income, it doesn’t always give specific details about your current assets and liabilities
that are pending the way a balance sheet does.
Other financial reports simply show transactions that have occurred, but a balance sheet gives you a rundown of transactions that need to occur to guarantee business progress. Your profit and loss statement may tell you your business is doing great if you have just made a really huge sale but your balance sheet will show you a huge debt you accrued in order to make that great sale which is a more accurate picture of the status of your business.
Your balance sheet being an ever-changing document on which you constantly write in new assets
you acquire or new liabilities that your company undertakes when updated frequently will give potential lenders and investors the information they need to make informed decisions about lending you money or other resources.
You balance sheet is like a display of your business’ capability since it shows your business assets, liabilities
and net worth. When compared to earlier versions, your current balance sheet even reflects your company’s ability to collect and pay debts over time and this is extremely important to investors as your balance sheet indicates whether or not you will be able to pay investors back.
From a balance sheet also, you can obtain an organized view of all your current liabilities
which may include short-term debts accrued in the form of accounts payable i.e. inventory or services you have purchased from other businesses, accrued expenses such as employees’ salaries or taxes that are soon to become due. Also, from the balance sheet, an outline of long-term debts such as loans can be obtained. This helps you compare the figures and accounts to assets
you own such as land, cash, prepaid accounts, equipments, inventory and accounts receivable i.e. goods and service provided to customers that are yet to be paid for. These information and analysis can help you determine priorities, such as liabilities
that need to be handled first and assets that need to be adjusted or collected to improve the cash flow of your business.
Yeah, you should also know this! In the business world, there are a lot of helpful ratios that people use to determine a company’s long-term profitability and short-term financial outlook. These numbers are of particular interest to those concerned about the credit or sustainability of your business or company and to anyone considering purchasing your company or shares of it. These ratios include the current ratio and the acid test or liquidity ratio, and they are calculated using information from your balance sheet.This is also one very important merit of the balance sheet.
Remember, a balance sheet shows what a company owns (assets), what it owes (liabilities) and where the company got its money (capital) from at a specific point in time. One of the most important parts of a balance sheet is the ‘net current assets
‘ section. This is the day-to-day finance that is needed for running a business. It is also referred to as ‘working capital’ and it is calculated by deducting current liabilities
from current assets
. Working capital is used to pay for expenses such as wages, raw materials and utility bills.
If a business does not have sufficient working capital then it can face problems when paying its short-term debts (current liabilities
). It may be the case that the business suffers a liquidity crisis and has to sell off some fixed assets
, for example, in order to raise the necessary cash to meet its debts.
It is vital, therefore, that close control is kept over working capital, and the business must ensure that it does all that it can to keep enough cash available to pay its current liabilities
. On the other hand, if the business has too much cash tied-up in working capital, then it can be argued that this cash is not being used productively to help the business grow and diversify into new products and markets.
It should be remembered, however, that the Balance Sheet is only one part of the financial statements required to give an accurate appraisal of the financial position of a business, and as such the importance of just one of these statements should not be over-emphasized. It is only by collectively analyzing the Balance Sheet, the Profit & Loss account and the Cash Flow Forecast of a business that an overall impression can be gathered on the financial strength of the business.