The balance sheet provides one of the most important windows into the overall financial health of your business. It allows management to plan for major expenditures, creditors to assess creditworthiness, and owners to identify risks and make wise decisions for the business.
All balance sheets follow a basic accounting formula: Assets = Liabilities + Owner’s Equity. Simply put, anything the business acquires for the purpose of generating income will result in either an obligation to a lender or an increase in the owner’s interest in the business. Here is a deeper look into each section of your balance sheet:
Assets are the life of your business; they are the property your business will use to generate income and satisfy outstanding obligations. The asset section of the balance sheet is listed in order of liquidity—often broken into two classifications known as current assets and non-current assets.
Current assets are all assets available for use within one year of the balance sheet date. Common current assets include:
- Cash – Including cash on hand, undeposited checks, and checking accounts
- Short-term investments – CDs maturing within one year; investments intended to be sold within a year
- Accounts receivable – Amounts due from customers for goods already provided or services previously rendered
- Inventory – Goods on hand available for sale to customers
- Prepaid expenses – An expense paid in advance of the period in which the benefit is received (such as insurance policies)
Non-current assets are your least liquid assets and will stay within your business for years to come. Typical examples of non-current assets include land, buildings, building improvements, equipment, and certain intangible assets such trademarks or patents. Businesses should have a capitalization policy specifying that property with a useful life greater than a year purchased over a minimum threshold will be capitalized and not expensed. Many small businesses elect to use the IRS de minimis safe harbor limit of $2,500, although this may vary depending on the type of business and the owner’s preference.
Liabilities are any obligations your business owes to any other entity, including vendors, banks, or other lenders. The liability section of the balance sheet is listed in order of maturity. Like assets, liabilities are broken up into current and non-current sections. Current liabilities also are expected to mature within one year of the balance sheet date and non-current liabilities are expected to have a life that exceeds one year. Typical current liabilities include:
- Accounts payable – Amounts due to vendors for goods previously provided or services already rendered
- Deferred revenue – Amounts paid by customers in advance for goods not yet provided or services not yet rendered
- Short-term loans – Consisting of amounts due within one year
Non-current liabilities typically consist solely of long-term borrowings that will be repaid over a span of time that exceeds one year.
Owner’s equity is any remaining claim an owner may have to assets after all liabilities have been satisfied. This section typically begins with any property an owner has directly contributed to the business followed by any distributions an owner has taken from the company over the course of the accounting cycle. Finally, an owner’s equity section will include a retained earnings line in which all net income or losses from an income statement or profit and loss statement over the life of the business are added together.
Assessing the Balance Sheet
Now that we covered many of the common elements of the balance sheet, how can this information help you make wise business decisions? Perhaps you have a business loan with a very high interest rate and want to pay it off. A balance sheet can help determine what your available cash is compared to the loan balance, and you can consider upcoming cash flow activity, e.g., accounts receivable, accounts payable, and loan payments coming due, to make an informed decision. Perhaps your cash flow needs are heightened, and you see on your balance sheet that there is a considerable amount sitting in accounts receivable. You can use that information to decide whether it makes sense to offer your customers a small discount for remitting prompt payments. These are just two examples of the many ways you can use your balance sheet to your advantage.
Whatever industry you are in, your balance sheet can be a great tool for managing the success of your business.
If you have any questions, please reach out to a professional at FORVIS. Want to learn how we can help with your small business financial reporting? Check out our Outsourced Accounting Services.