A survey on small businesses and their accounting habits showed that 60 percent of entrepreneurs felt that they did not have the required skills to manage their financial flow. Unfortunately, a proximately 82 percent of startups will fail because their cash flow is negative. The negative flow is attributed to failure to monitor daily financial activities. It eventually leads to the collapse of most businesses by the 5th to the 10th year.
Financial experts insist on keeping a balance sheet to monitor your assets, liabilities, and equity position. The information generated by the balance sheet will help an entrepreneur to make prudent financial decisions for the business.
What Is Accounting Balance Sheet?
A balance sheet is a record of the financial position of a business at a particular time. It captures details about your liabilities, assets, and equity position. Simply put, the balance sheet will give the actual net worth of any business.
A balance sheet is prepared for a particular period like a day, week, month, and year, among other preferred durations. A progressive look at the intervals will give you an idea of how your business is performing. You can determine whether it is making any profit or you are headed to closure due to losses. You can also determine whether you will get to the desired financial goals based on the prevailing performance. It will give you a clear idea of areas that need improvement if certain financial goals are to be achieved.
A balance sheet forms a trilogy of documents that are crucial in determining the health of your business. The other two documents that will indicate your performance are
- Income statement- it indicates the net income for your business. The income is calculated as the difference between your revenue and expenditure.
- Cash flow statement- it shows how cash is moving or cash equivalent flows in and out of your business. If you trace a trend of chronic negative flows, you should be alarmed at the direction that your business is taking.
Shareholders and tax authorities require you to prepare these three documents every accounting year. The details captured in these documents are also crucial when selling it or opening up to shareholders because they can see the liquidity position and net worth.
How Accounting Balance Sheet Works ?
A balance sheet is a perfect document to represent the financial position of a company or business at a given moment. On its own, it fails to give trends unless you compare the information from one year to the other or across the months. You may also want to compare the results with the performance of peers in the industry.
A balance sheet will help you to extra particular ratios that are crucial for your business. The ratios include acid-test ratio which indicates the short term assets and liabilities to see whether it can meet its financial obligations and the debt to equity ratio which is a comparison of liability to equity position to see the actual value to shareholders.
How the Balance Sheet is Structured ?
The structure of a balance sheet is set in accounting laws. Its accuracy will help you to monitor the performance of your business as well as meet regulatory requirements. Businesses should Hire Expert Online Payroll Processing to ensure that their balance sheets are accurate and represent the actual financial positions of these businesses. The accuracy of the information on your balance sheet will depend on how it has been collected and entered at different points in your operations. You, therefore, need to set up effective systems and software to capture the information at all points.
The structure of a balance sheet must capture three crucial elements of a business.
- Assets – the account captures items from the most liquid to the least possible to liquidate. It gives you an idea of the assets that can provide cash for the business and those that would be a struggle to convert into cash in case you need the money for your operational purposes. You must also include assets that would be impossible to convert into cash, like inventory and machinery.
- Balance Sheet : The general order of presentation on a balance sheet is to start with cash and cash equivalents, marketable securities, account receivables, inventory, and prepaid expenses. These are short-term assets that can easily be converted into cash. They are then followed by long term assets like securities that cannot be liquidated in a year, fixed assets like machinery, land, and buildings, and finally the intangible assets like intellectual properties and goodwill. You should only list the acquired and not in-house developed assets.
- Liabilities – these are monies owned to external entities. The liabilities include unpaid bills, interests on bonds, and pending payment to suppliers, among others. An expert virtual bookkeeping assistant will provide the tools and knowledge to keep track of your liabilities and ensure that accurate entry helps you to keep clean records.
Liabilities are listed as a current or long term. The current liabilities are those that would affect your immediate operations like utility payments, tax, rent, wages, customer prepayment, and current portions of long-term debts. The long term liabilities will include deferred taxes, pension fund liabilities, and long term debts. Some liabilities will not go into your balance sheet. The guidance of a professional accountant is needed to maintain accuracy.
- Shareholder equity – this is the money attributable to owners of the business or shareholders. It may also be referred to as net asset because you arrive at the amount by getting the difference between assets and liabilities. Some of the entries under shareholder equity include retained earnings, treasury stocks, paid-in capital, and other items that indicate the investment preferences of the business.
While a balance sheet is good for your business, it has limitations that are worth watching. Its static form might not give the most recent and accurate image of the business. Depreciation and inventories will also cause changes in your accounting books and may mislead a person relying on the balance sheet without accompanying footnotes.
Balance Sheet Formulas & Calculations:
A balance sheet will provide crucial information on the performance of a business. This position is calculated using formulas upon the extraction of information from the balance sheet. Here are crucial formulas to extract information and aid in your analysis of a balance sheet.
- Total Assets formula= liabilities + owner equity
- Working capital = current assets- current liabilities
- Debt to Equity Ratio= Total Debt/ Shareholders Equity
- Current ratio= current assets/current liabilities
- Acid Test= (Current Assets-Inventory)/Current Liabilities
The formulas can help you to determine the position of a company at a glance. For instance, in a normal scenario, the assets of a business will increase with an increase in debts. It means that an increase in liabilities will signal an increase in assets. Another verification formula is that increase in credit will result in the growth of liabilities and equity. You can extract as much information as you want from a balance sheet using the formulas provided.
Accounting Balance Sheet Examples
Here is a balance sheet example of a company with all the elements that will give you an idea of its financial performance.
Example 1
Notice the order of presentation for assets and liabilities. Equity comes at the tail end to give you a better understanding of the overall financial strength of the company. You can pick the totals of each section and apply the formulas above to calculate ratios and asset values.
Example 2
The second example goes ahead to calculate the equity position of the business. You can use the formulas provided to determine the financial position of the business and whether it is operating on healthy ratios.
Cash Flow Management (Cash Flow Statement)
Daily operations of a business are dependent on its liquidity. If the company cannot find the cash to run its day-to-day operations, it may grind to a halt despite having very lucrative assets. That makes cash flow management crucial for any entity. Even without an accountant to monitor your cash position, a virtual bookkeeping assistant will help you maintain a healthy liquidity position. You can monitor, analyze, and optimize your cash position so that it works for your business. Simply put, you make your cash-in and cash-out to balance in a way that will keep your business running regardless of the frequency of cash into the business.
Cash flow management ensures that the available cash is spread evenly through the year or a period so that your operations are covered. Seasonal businesses need to keep them running during the low season. At the end of a period, you will prepare a statement of your cash flow, helping you to plan for a similar season next year, or month.
Final Word:
A balance sheet can be considered as the measure of the health of a business. It has a dashboard element that can be used to monitor your performance. Without hiring an account in-house, Online Accounting Services will help you maintain a comprehensive and accurate balance sheet for your business.
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