By – nsjfinancialservices
24.08.22 08:55 PM
Understanding and Creating a Balance Sheet – The Basics
What is a Balance Sheet?
A balance sheet is an accounting report that balances assets, liabilities, and equity. It’s a snapshot of the financial health of a company. Understanding the balance sheet will help you identify strengths and weaknesses in a company’s financial position so that you can make informed decisions when investing in stocks.
A balance sheet typically has three main components — Assets, Liabilities, and Equity— that keep record of what an organization owns, what it owes, and its residual ownership. A balance sheet also helps users understand how much value the business has compared to how much it owes. Keep reading to understand the importance of balance sheets, examples of balance sheets from public companies, some best practices for your own business accounts, and step-by-step instructions on how to create one for your own business.
Why are they important?
A balance sheet is one of the key elements of financial accounting. It helps you understand how a company is performing, as well as its financial health. A balance sheet also gives you a snapshot of a company’s financial position at a given point in time.
Important Definitions
Assets
Assets are things that you own, such as cash, stocks, and real estate. They’re the parts of your business that give you money to use and keep track of. When you have more assets than liabilities (the amount you owe), you’re in a strong position. When thinking about assets in a balance sheet, it’s important to consider both current and future values. Current values are usually listed under current assets, while future values are usually listed under long-term assets.
For example, if you have $5,000 in cash in your bank account today, this is a current asset, since you can use it immediately. On the other hand, if your savings account has $10,000 in it from years past and there’s no way of knowing what the value is today or whether it will continue in the future, this is a long-term asset.
Liabilities
A liability is a financial obligation of the company. Liabilities can be either current or long term.
Current liabilities are debts due to be paid within one year. Long-term liabilities are debts that are not due until more than one year from now. As an example, in a balance sheet, a company’s current liabilities are the money it owes immediately, like accounts payable and payroll expense.
Long-term liabilities are the money the company owes after more than a year, like long-term debt and mortgages. Liabilities help you keep track of your company’s financial health by showing you how much money the company has to pay its current and future bills.
By subtracting assets from liabilities, you can see how much cash your business has left over for other uses, like paying down debt or investing in new equipment or facilities. If you have a lot of assets and few liabilities, your business is likely financially healthy. This means that if you choose to sell your company, you have a good chance of getting a good price for it because there’s enough money to go around for everyone involved.
Equity
Equity is the difference between assets and liabilities. You can think of Equity as a representation of how much you own versus how much you owe.
There are two types of equity – financial equity and owner’s equity.
Financial equityrefers to the difference between assets and liabilities such as cash in your bank account or cash on hand vs. debt owed to other people such as a mortgage.
Owner’s equity refers to the difference between assets owned by you such as your home or stocks vs. assets owned by someone else such as a corporation or partnership.
Finding The Hidden Red Flags | Analyzing Your Balance Sheet
The best way to improve your balance sheet is to start looking for red flags in your current balance sheet. This will show you where your company excels and where it needs help or advice. You can start with the following items to find red flags in your current balance sheet.
- Assets: Do you have enough assets to cover your liabilities?
- Liabilities: Are your liabilities too high?
- Assets and Liabilities: Do your assets and liabilities have equal signs?
- Cash flow: Is your cash flow positive or negative?
- Break-even analysis: Is your break-even analysis accurate?
- Profitability: Are you making a profit and how much?
- Investment and return on investment: Are you getting a return on your investment?
- Free cash flow: Do you have enough free cash flow to survive?
- Ratios: Do your ratios make sense and are they normal?
3 Best Practices for Your Own Balance Sheets
Analyze your ratios.
Ratios like the current ratio, inventory turnover, and operating margin show how efficiently your company is running. If your ratios are abnormally low or high, it could be a sign that something is wrong. If they are low, your company may be in trouble. If they are high, you may be overinvesting.
Make sure your cash flow is positive.
Cash flow shows how much money is coming into your company and how much is going out. If your cash flow is negative, it means you are spending more than you are making. You need positive cash flow to survive and stay in business.
Make your asset-to-liability ratio positive.
Asset-to-liability ratios show how much you have in assets compared to how much you owe. If your ratios are low, it could be a sign that your company is in trouble. If your ratios are high, your company is not likely to go out of business. Your goal is to make your asset-to-liability ratios positive so that you have more in assets than you owe in liabilities.
Key Takeaway
The best way to describe a balance sheet is that it is a snapshot of a company’s finances. It shows what a company owns, what it owes, and its net worth. Prioritizing your accounts can allow you to get a full picture of your business’s financial standing, allowing you to act accordingly and make better decision. Understanding your numbers is vital to growth. It is important that you choose an accounting professional who actually cares about the growth of your business and can give you relevant advice when you are making major decisions. Looking to hire an accountant for just that job? Contact us here at NSJ Today!
