Building a balance sheet is an important practice that must be conducted on either a quarterly or monthly basis. This financial statement provides insight into your company’s financial health by detailing your assets, liabilities, and shareholders’ equity.
Not sure how to create a balance sheet? Below, we’ll delve into the purpose of creating balance sheets and then provide a step-by-step guide of how to make your own. Jump to the section that interests you most:
- What is a balance sheet?
- The purpose of a balance sheet
- What's on a balance sheet
- How to make a balance sheet
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What is a balance sheet?
An accounting balance sheet is a snapshot of your company’s financial situation. It helps with financial planning and allows a business to see the owner’s equity. It’s one of the three fundamental financial statements that every business owner needs to have in order to perform financial modeling and accounting—the other two documents being an income statement and cash flow statement.
At its essence, an accounting balance sheet is one of the most accurate ways to analyze the company’s financial position. When fleshed out, a balance sheet can show you:
- What the business owns
- What the business owes
- How much has been invested into the company
As the name suggests, your company’s assets must always be equal to the combined value of your liabilities and equity. Some business use hedge accounting to reduce volatility impact in financial statements, however, the sheet must be balanced. If either is out of alignment, your calculations or notations are incorrect. According to Harvard University:
“A balance sheet is a financial statement that communicates the so-called ’book value’ [assets - liabilities] of an organization, as calculated by subtracting all of the company’s liabilities and shareholder equity from its total assets.”
The purpose of a balance sheet
A balance sheet is a snapshot of the company’s financial position at a specific point in time. It’s a critical measurement both internally and externally, but for different reasons:
Balance sheets help you see whether a business is succeeding or struggling. By analyzing your liquidity position (i.e. cash and receivables), you’ll see whether you can afford upcoming expenses or handle a market shock. Additionally, you can analyze historical trends in your assets and liabilities to ensure your business is running properly, or to identify problem areas quickly. If the numbers don’t look good, it can prompt an internal shift in how you conduct the business.
Balance sheets are a tool that help investors, stakeholders, and external regulators gauge the financial position of a business, what resources are currently available, and how they were financed. For investors, this can help them see whether or not it would be smart to invest in the company. They can extrapolate upon these numbers to determine other financial metrics like debt-to-equity ratio, profitability, and liquidity. For external auditors, a balance sheet can help them confirm that the company is complying with reporting laws.
What’s on a balance sheet?
Practically every balance sheet boils down to the following equation:
Assets = Liabilities + Shareholder’s equity
In addition, this equation is tied to a particular date, known as the “reporting date.” Although it depends on your business, in most cases, a balance sheet should be prepared and then distributed at least on a quarterly basis, if not monthly. Larger businesses will often create monthly balance sheets, while small businesses or startups typically create them quarterly.
Balance sheets are made up of three key elements:
The asset section of a balance sheet reveals what items of value your business owns. These assets are typically arranged by order of liquidity—in other words, how easily they can be converted into cash. This typically breaks down further into two categories of assets:
Assets that could likely be converted into cash within a year. These have various sub categories, including:
- Cash and cash equivalents – Your most liquid assets—cash, checks, and money kept in your checking and savings account.
- Accounts receivable – Money your clients owe that will be paid in the near future.
- Marketable securities – Traded investments that you can easily sell off.
- Prepaid expenses – Valuables you’ve already paid for such as insurance or rent.
- Inventory – Equipment, raw materials, and finished products.
According to Investopedia, long-term assets (also called non liquid or illiquid assets) are defined as “a company's value of property, plant, and equipment that can be used for more than 1 year, minus depreciation.” These include:
- Fixed assets – Property, buildings, equipment, and machinery.
- Intangible assets – Nonphysical assets such as patents, copyrights, licenses, and franchise agreements.
- Long-term securities – Investments that can't be sold off within a year such as bonds or real estate.
The liability section of the balance sheet demonstrates what money you currently owe to others, this includes recurring expenses and various forms of debt. Liabilities are broken down into two subcategories. They are either a long-term liability or a current liability.
- Current liabilities – Utilities, taxes, rent, accounts payable, and payments toward long-term debt interest.
- Long-term liabilities – Bonds payable and long-term debts.
This is the value of funds that shareholders have invested in the company as well as retained earnings. For retained earnings, the company must pay out dividends from the net income. Shareholders’ Equity = Total Assets – Total Liabilities.
How to make a balance sheet
Now that you know what’s in a balance sheet, how do you make your own? Follow these steps:
Step 1: Pick the balance sheet date
A balance sheet is meant to show all of your business assets, liabilities, and shareholders’ equity on a specific day of the year, or within a given period of time. Most companies prepare reports on a quarterly basis, typically on the last day of March, June, September, and December. Companies may also choose to prepare balance sheets on a monthly basis, in which case they would report on the last day of each month.
Step 2: List all of your assets
Once you’ve set a date, your next task is to list out all of your current asset items in separate line items. To make this section more actionable, it’s best to separate them in order of liquidity. More liquid items like cash and accounts receivable go first, whereas illiquid assets like inventory will go last. After listing a current asset, you’ll then need to include your non-current (long-term) ones. Don’t forget to include non-monetary assets as well.
Step 3: Add up all of your assets
After detailing your various asset categories, add them all up. The final tally will then go under the total assets category. To ensure that your numbers are correct, double check this figure against the company’s general ledger.
Step 4: Determine current liabilities
List the current liabilities that are due within a year of the balance sheet date. These include accounts payable, short-term notes payable, and accrued liabilities.
Step 5: Calculate long-term liabilities
List the liabilities that won’t be settled within the year. These include long-term notes, bonds payable, pension plans, and mortgages.
Step 6: Add up liabilities
Add up the current liabilities subtotal with the long-term liabilities subtotal to find your total liabilities.
Step 7: Calculate owner’s equity
Determine your business’ retained earnings and working capital, as well as the total shareholders’ equity. Retained earnings are the business’ profits which are reserved for reinvestments (not distributed as dividends to shareholders). Shareholders’ equity is the combination of share capital plus retained earnings.
Step 8: Add up liabilities and owners’ equity
If your liabilities + equity = assets, you’ve performed the balance correctly. If it doesn’t, you may have to go back and review your work.
Ramp: greater visibility & helping you close books faster
By building your three core financial statements (balance sheet, income statement, and cash flow statement) into your calendar, you’ll enjoy greater visibility into your company’s financial future. However, building balance sheets on a quarterly or monthly basis can be a time-consuming process even with accounting software.
That’s where Ramp comes in.
Ramp is the only corporate card that can help you streamline the balance sheet creation process and close books faster at the end of the month. This is accomplished thanks to the automated expense management and real-time spend tracking platform built into the card.
With Ramp on your team, it’s easier to create a balance sheet and close your books faster. Check out Ramp’s capabilities today, and enhance your company’s finances.
The term balance sheet is defined in our Ramp Finance Glossary.