The foundation of every small business financial report, the balance sheet is a snapshot of the health of your company. Many small business owners are intimidated by the mention of creating a balance sheet, but when put into its most practical terms, a balance sheet can become a useful small business accounting tool for future business strategies. Let’s review the basic structure and dispel some of the fears behind bookkeeping and the balance sheet.

What is in a balance sheet?

A balance sheet can show what a business owns in the form of assets and owes in the form of liabilities. In most well-managed businesses the balance sheet is generated monthly to help the business owner check the status of the company.  It can be used as a decision-making tool along with several other accounting reports. Much can be learned by examining a company’s assets to liabilities ratio.  The balance sheet provides a snapshot of how a company pays for both its assets and liabilities (debts) and how it maintains a balance between the two.

Included on the balance sheet are the following pieces of information:

·       Assets (cash on hand, cash in the bank, accounts receivable, inventory, property, etc.)  A simple formula for calculating total assets is Assets = Liabilities + Equity

·       Liabilities (loans, accounts payable, accrued payroll, taxes and customer deposits)

·       Equity (Owner’s or Shareholder’s Capital)

Assets include any assets that can be turned into cash or liquidated in 12 months’ time. Inventory is often any business' largest asset and is valued at replacement cost.  If there were a natural disaster tomorrow and your entire inventory was destroyed, what is the cost to replace all items? What are the costs of inventory management including storage, staffing to maintain it and machinery used to pick and pack it? Are there ways to reduce inventory costs while still providing a wide selection to your customers?

Liabilities can be a good thing for a business if they are well balanced with assets and there is a plan for the repayment of debts.  There are two categories of liabilities: current liabilities, or those that extend and can be paid within the course of 12-months; and long-term liabilities which include those obligations which extend beyond a year in repayment.  Remember to list your liabilities according to order of priority of payment.  Similarly,  assets should be listed in hierarchical order from most easily liquidated to most difficult.

Whether your business is a corporation or a sole proprietorship, equity is a calculable figure on the balance sheet.  Known in small business accounting circles as the ‘book value’ of a company, equity is the source of a company’s assets.  In a sole proprietorship, equity is referred to as Owner’s Equity. In a corporation, equity refers to the shareholder’s equity and is reflected as assets minus liabilities.  For more complicated formulations and working with common stock, you may want to seek the advice of a small business accountant who specializes in business valuations. 

Accounts receivable (A/R) is what is owed to the business by your customers.  It is especially important to have a current understanding of what is owed and how many days past due any accounts may be.  There will always be a percentage of accounts receivable that will not be paid and should be counted as bad debts.  The goal is to always strive for 100% payment, but do your business a favor and calculate a percentage of A/R as 'no pay' to have a more accurate amount of assets accounted.

Remember to include any pre-paid expenses such as rent, service plans, or any other unused but paid for expenses.

Know the impact of dates.

As mentioned above, balance sheets are similar to a photograph in that they can only provide financial information about a company in a frozen period of time.  That’s why it’s important to have a clear understanding of the dates represented in the balance sheet.  For a clearer year-to-date or year-to-year comparison, it is common practice to use ‘averaging’ to gain a more accurate number. Take the year-end totals for assets for two consecutive years and divide by two.  This number will provide a number that won’t overestimate the current year and give a feasible place from which to work for planning purposes.

Why create a balance sheet?

Balance sheets can provide useful data to banks and other interested parties when considering your company for financial transactions or even potential mergers or acquisitions.  By providing the most accurate information possible, your balance sheet can also be used as another planning tool for future business decisions (how risk averse are you?) and to gain a clearer picture of your company against the competition (how much are you spending to sell a similar product or service?). 

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations. To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice.  Any information contained in this article does not fall under the guidelines of IRS Circular 230.

Copyright Information 2011 Professional Association of Small Business Accountants