The balance sheet is one of the most important financial statements for any business, large or small. It reveals the value and health of a company at a single point in time. It shows what a company owns, what it can turn into cash and the debt or money it owes to others. It is also deeply connected to the other financial statements and can’t be analyzed in isolation.
The balance sheet has a few basic parts: assets, liabilities and shareholders’ equity. It will vary slightly between different organizations, but there are some common “buckets” and line items found in all balance sheets. The balance sheet is typically arranged with assets on the left side and liabilities and equity detailed on the right. This is in keeping with the accounting equation, which states that a company pays for what it owns by borrowing money as debt (liabilities) or taking money from investors and shareholders (shareholders’ equity).
Assets are any items your business owns that have inherent, quantifiable value. This could include physical things like inventory or equipment, or intangibles such as patents or trademarks. Assets are tallied in the positives section of your balance sheet, while negatives are listed as liabilities or depreciation and amortization expenses in the liabilities section of the balance sheet.
Liabilities are a company’s debt and other non-debt financial obligations, such as accounts payable and payroll. These are recorded on the liability side of the balance sheet, while current assets and future cash flows are recorded in the shareholders’ equity section. Shareholders’ equity includes the initial amount invested in your business, as well as a company’s retained earnings and capital reinvestment. The balance sheet must always balance, meaning that all total assets should equal all total liabilities and shareholders’ equity.
The balance sheet reflects all transactions since your business’s inception, which means that every transaction has been included in the final balance sheet number. This makes it a powerful tool for analyzing your business’s current position and predicting future trends. For example, by comparing current assets to current liabilities, you can see whether your company has the ability to pay for upcoming expenses or weather a market shock.
You can use your balance sheet to calculate several key metrics and ratios, such as the leverage ratio or return on assets. The leverage ratio demonstrates how much of your company’s capital comes from debt, while return on equity shows the percentage of profit from your shareholders’ investments. A good way to measure the strength of your company is by dividing net income by total shareholders’ equity, which will give you the company’s operating profitability percentage. If the ratio is too high, it could indicate a lack of growth opportunities or an overabundance of risky assets. This can be corrected by reducing the amount of debt and increasing the amount of profitable assets. In other words, it’s a good idea to keep the ratio below 80 percent. Bilanz