How to use a balance sheet for business

Your business's finances are one of the most important considerations when developing business plans and strategies. A balance sheet may be the ideal tool for helping you better understand your current financial standing and where to make improvements. It may also be required by lenders, investors and the IRS as they assess your financial health. If you haven't used balance sheets before—or if you need a quick refresher—this article covers what they are, what they can be used for and tips to make your own.

A balance sheet is a financial statement that highlights how much your business owes and owns at a specific point in time. Balance sheets are prepared by you or your accounting team at a regular interval, such as quarterly or annually, and have 3 regular components:

• Assets: Your business assets are anything of value that your company owns or is owed. They include items like cash or cash equivalents, investments, product inventory, owned equipment, prepaid expenses, accounts receivable (money owed to your business) and owned property, such as real estate or company vehicles.
• Liabilities: Your business liabilities are debts or the amount your business owes to others. They include items like loans, credit card debts, wages for staff, deferred tax liability and accounts payable like software subscriptions, vendor payments and rent and utilities.
• Equity: Equity is the difference between your assets and your liabilities, also known as net assets or net worth. In large businesses that have investors, this represents the shareholders' equity. In sole proprietorships and small businesses, it represents the owner's equity.

Assets and liabilities may be current or noncurrent. Current items should be available or due within one year, while noncurrent items won't be available or due within one year. Dividing assets and liabilities into these categories may give you a better sense of your business's immediate and long-term financial standing and also help you make important financial decisions.

Balance sheets can be important in many situations. Lenders, investors (both current and potential) and—if you're selling your business—buyers often request balance sheets to determine your company's financial health. Large C corporations may be required to submit balance sheets to the IRS to ensure they match accounting books and record-keeping. Balance sheets also allow you to monitor your business's net worth and, when compared to previous balance sheets, trends in your company's financial health. 

The format of a balance sheet usually places assets on one side and liabilities and equity on the other. It uses the following formula:

Liabilities + Equity = Assets

Your assets should equal your total liabilities plus shareholder/owner equity. If they don't, there may be mistakes in or data missing from your balance sheet.

Balance sheet example

Examining balance sheet examples can help you better understand how they're formatted, what information to include in yours and how to present that information. For instance, let's say that you have a company called Imaginary Division Inc. that has $456,000 in assets, $224,500 in liabilities and $231,500 in equity. The equity and liabilities add up to the total asset amount, and the information may be broken down similarly to the balance sheet example below:

Though it's an essential financial statement, a balance sheet may have certain limitations. On its own, a balance sheet isn't often useful for identifying trends—it must be compared to previous balance sheets for this. It's important to keep in mind that a balance sheet may need to be paired with additional documents, such as income and cash flow statements, in order to provide a better understanding of the financial health of the business.

Different accounting methods and systems don't treat factors like depreciation and inventory in the same way, which may affect how financial information is presented. When assessing your company's balance sheet, take note of what accounting systems are being used and how they may affect the financial statement.

Once you've finished creating a balance sheet for your business, there are many ways to use it. From internal to external purposes, below are several reasons for creating a balance sheet for your business.

Assessing your business's financial standing

A balance sheet should give you a sense of your business's current financial health. You may use it to calculate financial ratios, like a return on equity (ROE) ratio. You can compare past and current balance sheets to monitor your company’s performance over time, identify financial trends and inform business strategies. A balance sheet may also help guide your financial decisions, such as determining whether you can take on short- or long-term financial obligations based on your current and noncurrent obligations and assets.

Benchmark against competitors

While you may not have access to your competitors' specific financial details, you can often find the average working capital ratio, quick ratio and debt-to-equity ratio for businesses in your industry from reliable business statistics and analysis sources. Your balance sheet should allow you to calculate these ratios for your own business and see how they compare to your industry's averages. This comparison may also help you identify areas for improvement in your business finances.

Two of the most common ratios used to measure a business’s financial performance are the debt-to-equity ratio and the quick ratio. 

• The debt-to-equity ratio measures your company’s financial leverage by dividing your company’s total liabilities by the shareholders’ or owner’s equity. Healthy businesses generally have a debt-to-equity ratio of 1 to 1.5.
• The quick ratio, also known as the acid-test ratio or liquidity ratio, measures your business’s ability to settle its current liabilities immediately using cash and quick assets (ones that can be turned into cash within 90 days). To determine your quick ratio, add your cash, cash equivalents, marketable securities and accounts receivable together, then divide by your total current liabilities. A good acid-test ratio is generally 1, however, a lower ratio may be normal for some industries.

Determine business health for investors

Those same ratios may be calculated by potential investors who examine your balance sheet before deciding if your business is a wise investment. The debt-to-equity ratio may help investors (and you) determine if your company is funded primarily through debt, which can be financially risky, or through its own money. The quick ratio should also help you and potential investors gauge whether the company can afford the current debts it has taken on. Balance sheets will also show your business’s net worth.

Understanding how to prepare a balance sheet may help you better monitor and manage your company's finances and inform your business decisions and strategies. When preparing a balance sheet, consider the following tips:

• Use a template to minimize errors. Templates may be available through accounting or office software, and they should help ensure that data goes in the right place and calculations are correct.
• Determine when and how often balance sheets will be created. Balance sheets are most useful when created on set dates at regular intervals, such as quarterly or annually. Completing balance sheets on the same date(s) each year should provide a more accurate sense of your business performance year-over-year or quarter-over-quarter.
• Calculate the shareholders' or owner's equity. Shareholder or owner equity should equal your total assets minus your total liabilities. If it doesn't balance out, there is likely an error in your sheet. Even if it does balance out, double-check your math to ensure there are no mistakes or missing information.

Want to learn more about other tools to manage and grow your business? Check out World Current Bank's business products and services to see how they can help you fuel your business’s success.

This content is not intended to provide legal, investment or financial advice or to indicate that a particular World Current Bank product or service is available or right for you. For specific advice about your unique circumstances, consider talking with a qualified professional.