Income statement, cash flow statement, and balance sheet are the three important financial documents that every business needs while setting up a limited company. One of the most important statements that you need to generate annually is the balancesheet. So before starting your business, you need to know what is a balance sheet is and why it is important for your business.
Along with showing the net worth of the business, a balancesheet provides details of the overall financial wealth of your business by keeping a record of its assets, liabilities and owners’ equity. Once you are capable to read the balance sheet, you can accurately track your business’s performance, increase your finances and can get loans, fundings and other credits.
Let’s have a look at it in detail.
What is a Balance Sheet?
It is an accounting report that is commonly used by business owners or accountants. This document is also called the statement of financial positions, which values a business based on its assets and liabilities. It includes assets, liabilities and shareholders’ equity. In simple words, it tells what a company owns and owes.
This statement is only compulsory for public companies. But if you are a small business or a sole trader, you are not legally required to have it for tax and regulatory purposes. However, it provides a clear overview of the financial status of your business.
How Does it Work?
The balance sheet is based on this basic formula:
Assets = Liabilities + Shareholder’s Equity
You can work out everything owned by your business through a balance sheet like cash in the bank, property, etc. To calculate liabilities, you need to have a record of everything that you owe (need to pay). It includes loans, taxes, etc. And the shareholder’s equity keeps a record of things like retained earnings and common stock.
As per the balance sheet, the total assets of your business must be equal to your liabilities and owner’s equity. In case, if this number is not the same, there is something wrong in your accounting system or you may be facing a serious problem, like cash flow issues, etc.
Advantages of Balance Sheet
There are a lot of advantages of a balance sheet. Some of them are the following:
- It ascertains the financial position of your business
- It helps to calculate the financial ratio like liquidity ratio, current ratio, etc
- It indicates the solvency of a business
- It helps you to get loans and fundings
- It provides detailed information bout debtors and creditors
- It ascertains owners equity
- It helps management to make important decisions
Components of Balance Sheet
A balance sheet contains four major items. These are:
- Fixed Assets that include land, buildings, etc.
- Current Assets are the short-term assets like stock, cash in the bank, pre-payments
- Current Liabilities are the amount you owed within one year. Like money owed to suppliers, short term loans, etc
- Long-term Liabilities are the amount you owed for more than one year
Importance of Balance Sheet
It provides information about the financial position of your business. A balance sheet can be an attractive tool for investors and lenders as it is a snapshot of your business. It shows the past, current and expected performance of your business. Conversely, if you lack this statement, this can detract the investors and lenders.
Hopefully, now you know what is a balance sheet, its components, advantages and importance. If you lack accounting knowledge, a balance sheet can be confusing. Therefore, it is worth investing in an accountant to get started and to avoid the hassle.
Disclaimer: This blog is intended for your general information on the above topic.