Understanding the Basics of Balance Sheets

A balance sheet is a key tool for understanding a company’s financial position, and it can help investors, creditors, and other stakeholders evaluate a company’s performance and determine its value.

Let’s take a look at what a balance sheet is, how companies should use it, and its benefits.

What is a Balance Sheet?

A balance sheet is a financial statement that shows a company’s financial position at a specific point in time. It provides an overview of a company’s assets, liabilities, and equity.

The balance sheet is divided into two main sections - assets and liabilities/equity.

1. Assets

The assets section of a balance sheet lists a company’s resources that can be used to generate revenue. This includes cash, investments, inventory, property, and equipment.

Assets are listed on the left side of the balance sheet. The total value of assets should always equal the total value of liabilities and equity. This is known as the accounting equation, which is:

Assets = Liabilities + Equity

2. Liabilities/Equity

The liabilities and equity section of a balance sheet lists the company’s debts and obligations, as well as its owner’s equity. This is listed on the right side of the balance sheet.

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How Companies Should Use a Balance Sheet

A balance sheet should be used by companies to monitor their financial health and make informed decisions about their operations.

• Determine how much money a company has to invest in new projects or to pay off debts
• Identify areas where it may need to cut costs or increase revenue

An important thing companies should do when creating a balance sheet is ensure that the information is accurate and up to date. This is achieved by regularly reviewing and reconciling accounts, updating inventory records, and verifying value of assets and liabilities.

Balance sheets can also be used to track changes in a company’s financial position over time. Comparing balance sheets from different periods allows companies to identify trends and make necessary adjustments to their operations.

For example, if a company notices that its liabilities are increasing while its assets are decreasing, it may need to cut costs or generate more revenue to stay afloat.

Benefits of Using a Balance Sheet

Using a balance sheet has many benefits, including:

Improved Decision Making

A balance sheet provides a clear picture of a company’s financial position, helping management make informed decisions about investments, expenses, and other important matters.

Enhanced Transparency

A company’s balance sheet provides stakeholders with a transparent view of its financial position. This helps build trust with investors and creditors and improves a company’s overall reputation.

Better Risk Management

A balance sheet can help a business identify potential financial risks and take steps to mitigate them. For example, if a company has too much debt, it may need to refinance or seek new sources of capital to reduce its risk exposure.

Improved Financial Reporting

Using a balance sheet to track changes in financial position over time allows companies to better plan for the future. This can include setting financial goals, creating budgets, and making adjustments to operations as needed.

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Different Balance Sheet Versions

Classified Balance Sheet

A classified balance sheet is very similar to a standard balance sheet in that it lists the same assets, liabilities, and equity values. The difference is that on a classified balance sheet, each area (asset, liability, equity) is further separated into classifications.

This gives those using the balance sheet a more granular look at each section and a better understanding of where cash flow is moving to and from.

Common Size Balance Sheet

This type of balance sheet is again very similar to a standard balance sheet, with the difference being that each entry for assets, liabilities, and equity is represented as a percentage of the total for each type.

Expressing the total as percentages makes it easier to identify trends and patterns of a company’s financial performance as well as comparing to industry benchmarks and competitors.

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Balance Sheet vs. Income Statement

A common question some business owners ask is: what is the difference between a balance sheet and an income statement? It comes down to time.

A balance sheet is like taking a picture of a company's financial position, seeing that status at that particular point in time. It shows a company's liquidity and solvency, which indicate its ability to pay debts and continue operations in the future.

An income statement is a view of a company's financial performance over a period of time, such as a month, quarter, or year. It shows a company's revenues and expenses as well as net income or loss. This shows a company's profitability and ability to generate earnings.

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Balancing Act

Companies use information from many sources to make business decisions. A balance sheet is a simple, transparent look at a company’s financial health, with many benefits to help companies keep their financial situation balanced.

If you need assistance with your financial statements or financial reporting, contact one of our accounting professionals.