One of the biggest challenges for small business owners is keeping up with bookkeeping and financial reporting tasks. Balance sheets are an important piece of financial information that every business owner needs to understand in order to monitor the financial health of their company. Together with income and cash flow statements, balance sheets provide business owners the financial data needed to make informed decisions.
What’s Included in a Balance Sheet?
A balance sheet provides a snapshot of a company’s assets, liabilities, and equity at the end of an accounting period. These three categories allow owners and potential investors and lenders to evaluate the overall financial health of a business:
- Assets are resources that generate revenue (or sales) and profits in a business. An asset may be tangible, like a vehicle, or intangible, like a patent or other intellectual property.
- Liabilities are amounts owed to other parties, including accounts payable (current liabilities) and long-term debt, including bank loans.
- Equity is the difference between assets and liabilities. It reflects the true value of a business. Equity is also referred to as shareholder equity, owner’s equity, or net worth.
At the core of the balance sheet is the accounting equation: Assets = Liabilities + Equity. A balance sheet shows what your company owns versus what it owes at a specific moment in time. If total assets do not equal liabilities and equity, the balance sheet is considered “unbalanced.”
Uses for Balance Sheets
Balance sheets are important for several reasons. They reflect important financial data that are used in the course of business transactions. Some typical uses for balance sheets include:
1. To Evaluate Risk and Return
A balance sheet lists all of your business assets and liabilities in one place. Current and long-term assets reflect your ability to generate cash and sustain operations. Short- and long-term debts prioritize your financial obligations.
Ideally, you would have more assets than liabilities, indicating a positive net worth. If your current liabilities exceed your cash balance, your business will likely require additional working capital from lenders or investors. A balance sheet can also reveal when debt levels are unsustainable.
2. To Secure Loans and Investors
Your balance sheet allows people to quickly understand the financial condition of your business. Most lenders require a balance sheet to determine a business’s financial condition and creditworthiness.
If you apply for a loan, your financial statements can help demonstrate to lenders that you are likely to repay your debts in a timely manner. Potential investors use balance sheets to understand where their funding will go and when they can expect to see a return on their investment.
3. To Make Long-Term Business Decisions
Tracking your business finances can help you identify potential issues before they become major problems. Most small businesses fail because of cash flow problems that can be identified early and corrected if balance sheets are accurate and up-to-date.
Small business owners often underestimate the importance of budgeting, overspend on startup costs and wait too long to seek credit. These common financial problems can be avoided by creating a sound business plan and using financial statements to guide business decisions.
4. To Prevent Potential Problems
The primary reason for a business is to make a profit. A well-run business should show increasing equity. If your business isn’t doing that, looking at specific assets and liabilities on your balance sheet can help you figure out why.
For example, if most of your assets are inventory, that could be creating unnecessary risk. Inventory that doesn’t sell can quickly become a serious liability.
5. To Make Tax Preparation Easier
Keeping accurate business records is important for both tax planning and preparation. The IRS recommends that small business owners maintain organized and up-to-date financial records in order to prepare accurate tax returns.
With your financial statements in order, your accountant or tax preparer will be able to accurately prepare your returns and ensure that you are not paying more taxes than you should. And in the event of an IRS audit, you will be required to present a complete set of financial records for inspection, including financial statements and receipts.
Know Your Business’s Financial Status
Preparing and understanding your company’s financial statements is an essential part of being a successful small business owner. The balance sheet is particularly important because it keeps you and other stakeholders informed of your financial position. Keeping this information updated can help you make better management decisions. In addition, it can help improve your operational efficiency, borrowing, and overall financial health.
Unless you’re a financial expert, trying to handle all of your business accounting tasks on your own is probably not the best use of your time. Whether you are just starting out or are an experienced business owner, outsourcing your bookkeeping and accounting is a smart idea.
A professional accounting firm will have the experience and resources to make sure your accounts are in order. They can help you understand and use your financial statements to improve your business operations.
Get the Accounting Expertise You Need
At Nolan Accounting Center, we pride ourselves on building strong relationships focused on success. Because our firm is relatively small, our clients benefit by receiving personalized service. By regularly meeting to review your financial statements, we can help you evaluate your financial situation and determine next steps for maximizing your success.
Nolan Accounting provides a full range of accounting, tax preparation, bookkeeping and payroll services to small business owners in Southeast Wisconsin. We look forward to working with you to meet your financial goals.