A balance sheet is like a road map of your business’s financial state and should be used as a reference point for most business decisions. Read on to learn more about balance sheets and get some tips on how to run your finances better.
Balance sheets explained
Balance sheets are an integral part of your business accounting. Without a thorough understanding of your company’s financial status, it can be very difficult to deal with the ongoing demands of running a successful business.
What is a balance sheet?
A balance sheet is a type of business statement that shows what the business owns (assets), what it owes (liabilities), and the value of the owner’s investment (owner’s equity) in the business. It also helps identify trends in the business and helps you manage your business finances, as well as your relationship with customers and suppliers.
Unless you have detailed knowledge of your company’s balance sheet or how to prepare one, it can be tough to see whether your business is on the right track or if you need to pursue additional business finance.
What is included in a balance sheet?
“A balance sheet should be a snapshot of a business’s assets, liabilities, and shareholder’s equity at a single point in time,” says Graham Davies, CEO and founder of Addition, a UK-based outsourced finance business for SMEs. That ‘single point in time’ is usually a year.
What does a balance sheet look like?
A balance sheet should have the following:
- Assets – divided into current assets and noncurrent assets. Current assets include valuables such as cash, vehicles, and equipment. Noncurrent assets are valuables that can’t be easily liquidated in less than a year, such as land or buildings, or even patents and copyrights.
- Liabilities – divided into current and long-term liabilities. Current liabilities include accounts payable (expenses you’ll be paying out in less than a year, including salaries, utility bills, and leases). Long-term liabilities are money you owe that won’t need to be repaid within a year, such as debt financing or a government-backed loan.
- Shareholder’s equity – the initial amount of money already invested in the business.
Why is a balance sheet necessary?
A balance sheet is needed for financial reporting and to ensure that your books balance. Checks done demonstrate that the transactions entered took place, are shown correctly, are for the correct period, and to the correct bank account.
According to Polly Arrowsmith, who runs a company specialising in concealment and detention equipment for the military and events, deals are made or broken on your balance sheet.
“In some sectors, providing a balance sheet for three years is key to getting business. Prospects want to know that you have enough cash before they proceed with you and that you will continue trading.”
How does a balance sheet help your business?
There are many ways in which a balance sheet helps your business, but these are some key examples.
Maintaining healthy cash flow
A balance sheet is key to spotting potential cash flow gaps. “For example," says Davies, "you might include ‘assets’ as money from sales you’ve already made when those invoices have yet to be paid by the client.”
Doing this exercise properly would show you a clear timeline between the point of sale and when the actual money comes into your business. If it’s longer than you’d like, you can think about ways to narrow any gaps in your cash flow.
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Making informed decisions
Keeping a close eye on your balance sheet also allows you to make informed business decisions.
“You should be able to spot trends easily on a balance sheet if you have a comparison from a previous accounting period,” says Arrowsmith.
If you are looking to raise money for your business – through a loan or sale of equity, for example – your balance sheet will become an essential document. Given that you may need to do this at short notice, you should always keep your balance sheet up-to-date.
Even if you don’t need to raise funds, a balance sheet with all current assets and liabilities will allow you to keep a close eye on the health of your business. Overall, a balance sheet helps you stay in control of your company’s finances.
How to keep your balance sheet updated
You should amend the balance sheet whenever there is a change in the business’ assets or liabilities. For example, if you sell a piece of key equipment or upgrade it so that it increases or loses value for a reason, you must add that to the balance sheet. If you take out any additional loans, sell property, or change company cars, your balance sheet will need to be updated.
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How your balance sheet relates to cash flow
While your balance sheet does not specifically show your cash flow, it works very closely alongside cash flow forecasts. This is another reason to keep your balance sheet current, as it will help you to understand what is coming into or going out of your business at any time. An accurate cash flow forecast means you can look ahead to ensure you will have enough funds to cover future bills, such as tax, VAT, or pension liabilities for your employees, as well as ensuring you won’t end up paying suppliers late.
Having a good handle on your cash flow is essential to running your business effectively. But without a clear and structured balance sheet with all liabilities outlined, your cash flow forecasting cannot be as effective, which puts your company’s financial future at risk.
Keeping your balance sheet in good order is vital for managing your business finances. It can help improve your cash flow, gain financing, and make quick and beneficial decisions at all stages of your business.
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