Preparing a balance sheet and keeping records of your financial records are necessary for any business. A Balance sheet basically tracks all the assets and liabilities of the company and also provides the current financial state of the company. Further, it is important for the company to prepare a balance sheet to help the financial team make wise financial decisions.
If you are a business owner or new to the business, having a financial team and maintaining a balance sheet becomes essential. Mostly at the beginning of the business journey, owners ignore investing in their financial health, which eventually leads to bad circumstances.
In this article, we will give you a step-by-step guide for preparing a balance sheet for your company. We will also help you understand the importance of the balance sheet for maintaining the financial health of your company. Let’s get started.
A balance sheet contains a summary of the financial expenses and balances of an organization or an individual over a period of time. It is a financial portfolio that shows a company’s assets, liabilities, and owner’s equity. There are various types of balance sheets, and some of the most common ones are:
- Classified – The balance sheet is the most classified and common and consists of all the information on assets, liabilities, and equities with their subcategories.
- Comparative – This balance sheet will provide you with the assets, liabilities, and equity information with side by side comparisons at multiple times.
- Common Size – This balance sheet includes the same information as other sheets and has one more column displaying the ratio of total assets, liabilities, and equities. This helps in making the percentage changes in the chart.
- Vertical – In this balance sheet, all the information is listed in one column and in decreasing order of liquidity.
Importance of balance sheet for businesses
A balance sheet for business is very important in many aspects, as it allows you to know where your business stands. Having your balance sheet equation can give you an insight into your business after the financial year ends, and you can plan accordingly for your expenses for the next period, which is usually every 12 months. Therefore, the balance sheet is also known as the statement of financial position or position statement because it provides all the details of the assets and liabilities of your business.
Let’s understand in detail the importance of preparing a balance sheet.
- Assessing Your Risks and Returns – When you have your balance sheet equation, you can compare your current assets with your current liabilities. You can make wise decisions about whether you have enough capital to cover your debts or whether you need more investments.
- Shows Sustainability of your Business – A balance sheet can predict the sustainability of your business because it is a constant indication of its financial health. With balance sheet analysis and financial ratios, you can assess the business’s position in terms of profitability, liquidity, and productivity. Also, the ratios are good for comparing your finances and balance sheets with those of your competitors.
- Helps in Getting Loans and Investments – Most banks, investors, and lenders check the balance sheet before planning to invest in your business. The balance sheet acts like your financial portfolio because it shows how you have performed with debts, repayments, and clients.
Understanding the Basics of a Balance Sheet
Before making a balance sheet, it is important to know and understand the basics of a balance sheet. Here we are going to explain some of the familiar terms used when preparing a balance sheet.
An asset is a property or anything that the company owns that has some quantifiable value, which means it can be turned into liquid cash. These are considered good sources owned by the company.
There are two types of assets:
- Current Assets – Also called short-term assets, these are what the company expects to turn into liquid money in a year’s time, such as cash, prepaid expenses, inventory, etc.
- Non-Current Assets – Also called fixed or long-term assets, these are the company’s investments to convert into cash in short-term land, property, equipment, trademarks, etc.
A liability is anything a company owes to the debtor. The liabilities of the company include payroll expenses, debt payments, utility payments, taxes, and bonds payable.
Liabilities can also be classified into two types:
- Current Liabilities – Also called short-term liabilities, these are due in one year, such as rent or payable expenses.
- Non-Current Liabilities – Also called long-term liabilities, these are obligations that the company is obliged to pay in the long term, such as leases, bonds, loans, etc.
Shareholders’ Equity refers to when all assets are sold, and all liabilities are paid from the company’s net worth. The amount left is then distributed as shareholders’ equity. This equity belongs to shareholders who have invested in the company, whether they are public or private owners.
Balance sheet’s importance in the financial reporting process
A balance sheet is a financial portfolio of your company that can send you timely reminders about your progress. Your financial team can work to prepare the balance sheet, which will contain all the information regarding new asset additions and liabilities in your company. Therefore, preparing a balance sheet is necessary for a successful business.
Step-by-Step Guide to Prepare a Balance Sheet
Here we are going to share a step-by-step guide on how to prepare a balance sheet and what important points you must consider while preparing it. We will present the balance sheet preparation steps:
1. Define Reporting Date and Period
Step one in the preparation of the balance sheet is to set a reporting date and period, as it is going to show all the assets, liabilities, and shareholders’ equity. Most companies make their reports quarterly or half yearly in the months of June, September, and December. Some companies choose to prepare the report on a monthly basis, after which they update the information at the end of the day.
2. Investing in Accounting Software
All the accounting work is technical and requires key-eye observation; the best thing the company could do is invest in accounting software. These programs have built-in functions to add the data and perform the calculations. You can avail yourself of many services from accounting software, as they are also leveled from basic to advanced. The basic ones require some knowledge to use. However, advanced accounting software does most of your work.
3. Set up your balance sheet
You can add your assets and liabilities to the balance sheet for a specific financial quarter.
How to prepare a balance sheet?
- Assets – Add the company’s assets, like resources that the company has been using, such as equipment or offices.
- Liabilities – Add the company’s liabilities, like rent, salary to employees, and any debt payments.
- Shareholder’s Equity – This shows the shareholder’s equity and the company’s earnings.
The total sum of assets equals the total sum of liabilities and shareholders’ equity.
4. Account of your Assets
You must dedicate the first five lines to the accounting of your assets. These include the amount of your current assets, which shareholders may plan to convert into cash in the coming year, and your long term assets. While listing the assets, you must order them as per liquidity, which will represent how quickly assets can be converted into cash.
Here we are going to share how to prepare a balance sheet section regarding accounts of your Assets.
- Add the amount of cash available at the business
- Add the accounts receivable or the current amount your customers owe while giving credit
- Add the company’s current inventory value.
- Only add the fixed assets of the company, such as equipment, land, buildings, and other valuable assets.
- Add total assets and calculate each asset’s value.
5. Accounting of Your Liabilities
List your liabilities, which are any repayments to the company, such as the due date for loan repayments, etc.
Here we are guiding you on how to write your liabilities on the balance sheet.
- List the credits of the business
- Add the long-term bank loans or any repayments business needs to make
- Add the company’s short-term debt, such as rent, EMIs, or amounts taken on credit.
- List the total amount the business owes, which includes the owner’s investment in the company too.
6. Finding Shareholder’s Equity
Depending on the assets and profits gained by the company over a period of time, you can divide the shareholders’ equity.
- List the owner’s investment in the company
- List the private or public stock amount invested
- Write the company’s retained earnings or revenue amount minus the expense from the start of the business.
- The last line shows the total equity of the business.
7. Adding Liabilities to Shareholder’s Equity and Compare to Assets
Now comes the final formula, you can calculate the liabilities to shareholders’ equity and compare them to assets. If there is any error in this, it means you made mistakes during the process.
Tips for Accurate and Comprehensive Balance Sheets
Preparing a balance sheet is one of its tasks, which requires a lot of understanding and transparency when it comes to dealing with money. As we mentioned earlier, you can revamp your balance sheet using accounting software that eases your work with accuracy.
- Consistency in accounting methods and policies – There must be consistency in accounting methods and policies so that you can keep track of the quarterly or yearly improvements in the business.
- Regular reconciliation with other financial statements – It is good to do a proper reconciliation with financial statements such as the income statements and calculate the working capital and debt-to-equity ratio.
- Proper documentation and record-keeping – With a balance sheet, you can have proper documentation of all the necessary assets and liabilities of the company. Also, this will be record keeping for future purposes.
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