- What is a balance sheet?
- How to make a balance sheet
- Balance sheet sample and template
- Advanced financial ratios derived from the balance sheet
- Using your balance sheet for business decisions
- How to avoid common balance sheet errors
- Take control of your financial reporting with Ramp
Building a reliable balance sheet doesn’t have to be complicated. In just a few simple steps, you can capture a clear view of your company’s financial health. Whether you're a small business owner, an accountant, or looking to secure a business loan, understanding how to create a balance sheet is a valuable skill for making informed financial decisions.
In this article, we’ll cover what a balance sheet is, why it matters, the key equation behind it, step-by-step instructions for creating one, and a sample template for your business.
What is a balance sheet?
A balance sheet is a core financial statement that provides a snapshot of your company’s financial position at a specific point in time. It includes details about assets, liabilities, and equity—the basic components used to measure your business's net worth.
Businesses usually prepare a balance sheet at the end of a financial period—monthly, quarterly, or annually—often as part of their month-end close process. Owners, investors, lenders, and accountants use it to evaluate a company’s liquidity and make informed financial decisions.
Balance sheet equation and format
The foundation of every balance sheet is the accounting equation:
Assets = Liabilities + Equity
This simple equation ensures that your company finances all its assets either by borrowing money or via investments from shareholders or owners.
Category | Description | Examples |
|---|---|---|
Assets | Everything your business owns, divided into current assets (easily converted into cash within a year) and non-current assets (long-term resources) | Current assets: Cash, accounts receivable, inventory, prepaid expenses Non-current assets: Property, equipment, intangible assets, long-term investments |
Liabilities | What your business owes, classified into current liabilities (due within a year) and long-term liabilities (due in the future) | Current liabilities: Accounts payable, short-term loans, wages payable, and interest payable Long-term liabilities: Long-term debt, deferred tax liabilities, and pension fund obligations |
Equity | The owner’s share of the company’s assets after liabilities are deducted. It represents the net worth of the company. | Owner’s equity or shareholders' equity: Common stock, retained earnings, additional paid-in capital |
Most balance sheets follow a format with assets on the left side and liabilities and equity on the right. The goal is for the two sides to balance out: Assets should always equal the sum of liabilities and equity.
Why a balance sheet matters
A balance sheet is crucial for assessing financial health. It shows whether your business has enough assets to cover its liabilities and highlights the equity that owners or shareholders have in the company.
Here’s how a balance sheet helps:
- Measuring financial health: You can see if your company is liquid enough to cover short-term obligations or if you have enough assets to pay off debt
- Attracting investors and securing loans: Investors and lenders look at your balance sheet to determine your company’s financial position before making decisions
- Supporting better business decisions: A balance sheet is essential for budgeting, strategic planning, and cash flow management
How to make a balance sheet
Creating a balance sheet is straightforward if you follow a simple step-by-step process. Here’s how:
1. Gather asset balances
Start by listing all your assets, separating them into current and non-current categories.
Current assets include:
- Cash and cash equivalents: Physical currency, checking accounts, and short-term investments
- Accounts receivable: Money customers owe you
- Inventory: Goods for sale or use in production
- Prepaid expenses: Payments made in advance for services or goods to be received later, such as insurance or rent
Non-current assets include:
- Fixed assets: Property, buildings, machinery, and equipment
- Intangible assets: Intellectual property, patents, trademarks, or goodwill
To calculate total assets, add the value of both current and non-current assets.
2. List all liabilities
Now, list all your liabilities—financial obligations owed to other parties, such as suppliers, banks, or employees. Like assets, liabilities are divided into two categories.
Current liabilities (due within a year) include:
- Accounts payable: Money owed to suppliers
- Short-term loans: Loans or credit lines due soon
- Wages payable: Employee salaries and benefits owed
Long-term or non-current liabilities (due after more than a year) include:
- Long-term debt: Loans or bonds due beyond one year
- Deferred tax liabilities: Taxes owed but deferred to future periods
Sum the value of your current and long-term liabilities to arrive at your total liabilities.
3. Calculate owner’s equity
Calculate owner’s equity—or shareholders’ equity for corporations—by subtracting your total liabilities from your total assets:
Owner’s or Shareholders’ Equity = Total Assets – Total Liabilities
Equity can include:
- Common stock (for corporations)
- Retained earnings (profits kept in the business for reinvestment)
- Owner’s capital (for sole proprietorships or partnerships)
4. Verify the accounting equation
Once you’ve listed all your assets, liabilities, and equity, double-check the accounting equation:
Assets = Liabilities + Equity
If the balance sheet doesn’t balance, you may have made an error in listing or classifying assets, liabilities, or equity. Double-check your calculations and recategorize any items as necessary.
Balance sheet sample and template
Here’s an example of how a completed balance sheet might look:
Category | Amount ($) |
|---|---|
Assets | — |
Current assets | 15,000 |
Cash and cash equivalents | 10,000 |
Accounts receivable | 5,000 |
Inventory | 10,000 |
Non-current assets | 20,000 |
Fixed assets | 10,000 |
Intangible assets | 5,000 |
Total Assets | 75,000 |
Liabilities | — |
Current liabilities | 7,500 |
Accounts payable | 5,000 |
Short-term loans | 2,500 |
Long-term liabilities | 10,000 |
Long-term debt | 10,000 |
Total Liabilities | 35,000 |
Equity | — |
Owner's equity | 40,000 |
Total Equity | 40,000 |
Get our free Balance Sheet Template
Advanced financial ratios derived from the balance sheet
Once you've created your balance sheet, you can derive key financial ratios to help you assess your company’s financial liquidity, solvency, and profitability.
Here are some of the most commonly used ratios derived from balance sheet data:
1. Current ratio
The current ratio measures your company’s ability to cover its short-term obligations with its short-term assets. Here’s the formula to calculate:
Current Ratio = Current Assets / Current Liabilities
- Example: If your current assets are $50,000 and current liabilities are $25,000, your current ratio would be 2.0
- What it indicates: A ratio above 1 means your company can cover its short-term liabilities with its short-term assets. Below 1 suggests you may struggle to meet short-term obligations.
2. Quick ratio
The quick ratio, also known as the acid-test ratio, measures your company's ability to cover short-term liabilities with its most liquid assets, excluding inventory. Here’s the formula:
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
- Example: If your current assets are $50,000, inventory is $10,000, and current liabilities are $25,000, the quick ratio would be 1.6
- What it indicates: The quick ratio provides a more conservative measure of liquidity, excluding inventory, which you may not always be able to liquidate easily. A quick ratio above 1 indicates solid liquidity.
3. Debt-to-equity ratio
The debt-to-equity ratio shows how much debt your business has compared to the equity invested by the owners or shareholders. You can use the following formula to calculate debt-to-equity ratio:
Debt-to-Equity Ratio = Total Liabilities / Shareholders’ Equity
- Example: If your total liabilities are $100,000 and equity is $50,000, the debt-to-equity ratio would be 2.0
- What it indicates: A higher ratio suggests that your company is heavily reliant on debt to finance its operations, which can be risky in the event of financial downturns. A lower ratio suggests a more conservative approach to financing.
4. Return on equity (ROE)
The return on equity measures how efficiently your company is using its equity to generate profit. Here’s the formula:
ROE = Net Income / Shareholders’ Equity
- Example: If your net income is $20,000 and equity is $100,000, the ROE would be 20%
- What it indicates: A higher ROE indicates your company is effectively using shareholder funds to generate profits. It’s an important metric for investors to assess the profitability of the business.
Monitoring these financial ratios can help you stay on top of your business's liquidity, solvency, and profitability. Use them to identify areas where you need improvements or to validate business strategies.
Using your balance sheet for business decisions
Your balance sheet is more than just a tool for tracking assets and liabilities; it plays a key role in shaping your financial strategy. Here are a few real-life scenarios where your balance sheet directly impacts critical business decisions:
Taking out a loan
When you apply for a business loan, lenders will often look closely at your balance sheet to assess your financial position. Here’s how the balance sheet influences their decision:
- Total assets: Lenders want to know if you have enough liquid assets or non-current assets, such as equipment or real estate, to back up the loan
- Liabilities: Lenders will review your current liabilities to ensure you can meet your short-term obligations while taking on new debt
- Owner’s equity: A strong equity position indicates to lenders that the business is well-capitalized
Example: If your current ratio (current assets/current liabilities) is 2.5, it indicates you have 2.5x the assets needed to cover your short-term liabilities. Lenders might view this as a positive sign when considering your loan application.
Planning an expansion
When planning an expansion, whether through new product launches, hiring more staff, or opening new locations, your balance sheet can help you decide whether you can afford the costs or need to secure additional funding.
- Assessing retained earnings: If your retained earnings are substantial, you might choose to reinvest these profits into the expansion rather than taking on additional debt or equity financing
- Identifying available credit: The balance sheet shows whether you have available credit or if you’re close to reaching your credit limits, which could affect financing options for the expansion
Example: If your total liabilities are too high relative to shareholder equity, it might be a warning sign that taking on more debt could hurt your financial stability during the expansion.
Monitoring cash flow and profitability
Regularly updating your balance sheet gives you insights into whether your business is on track to meet cash flow targets. For example, if your accounts receivable are high but cash on hand is low, it might signal that you're not collecting payments fast enough.
- Liquidity analysis: The quick ratio and current ratio will show whether you have enough liquid assets to meet upcoming expenses
- Profitability check: The balance sheet helps assess your retained earnings, which show whether your business is generating enough profits to reinvest or pay out dividends
Example: A debt-to-equity ratio of 3.0 may indicate that your business is heavily reliant on debt, making it less profitable and risky in the long term. This information helps you adjust strategies for profitability.
Attracting investors
Investors look at balance sheets to understand the financial health of a business before committing capital. A strong balance sheet signals to investors that the company is in a good position to provide returns while managing risks.
- Assets: Investors want to see whether the company has valuable assets—intangible assets such as intellectual property or fixed assets such as real estate
- Liabilities: A low debt-to-equity ratio indicates to investors that the business is not overly leveraged and carries less financial risk
Example: If you're seeking venture capital to fund a new project or product, a healthy balance sheet with manageable liabilities and strong equity might make investors more comfortable with the risk.
How to avoid common balance sheet errors
To make sure your balance sheet is accurate, watch out for these common mistakes:
Misclassifying assets
Avoid listing non-current assets as current assets. Non-current assets, such as property and equipment, are long-term resources and should only appear under the non-current section. Misclassifying them as current can distort your liquidity ratios and misrepresent your ability to cover short-term obligations.
Omitting liabilities
Always include both current and long-term liabilities. Current liabilities, such as accounts payable and short-term loans, are due within a year. Long-term liabilities, such as long-term debt and deferred tax liabilities, are due after a year. Missing either category can lead to an incomplete picture of your financial position and may result in errors when assessing your solvency.
Not updating depreciation
Regularly update depreciation on fixed assets to reflect their true value. As assets such as machinery or vehicles lose value over time, you must account for depreciation. Failing to update depreciation can overstate the value of your non-current assets and affect the equity section, which could lead to incorrect financial reporting.
Miscalculating equity
Make sure your owner’s equity or shareholder equity reflects the actual net worth of the company. You should calculate equity as total assets minus total liabilities. If there’s an error in asset or liability totals, it can result in an inaccurate equity figure, giving a false impression of your company’s financial health.
Take control of your financial reporting with Ramp
Accurate financial reporting is essential for making informed business decisions, and your balance sheet is at the heart of that process. With Ramp’s accounting automation software, you can eliminate complexity and time-consuming data entry, ensuring your balance sheet is always up-to-date and accurate.
By automating accounting tasks, you reduce human error, save time on reconciliation, and gain real-time insights into your financial health. This simplifies the balance sheet creation process and provides clarity needed for strategic decision-making. With Ramp’s automation, your finance team can focus on what truly matters—driving growth and profitability—while leaving the repetitive tasks to the software.
Try an interactive demo and see how Ramp helps you close your books faster
FAQs
No, you only list assets, liabilities, and equity on the balance sheet. Expenses are typically recorded on the income statement.
Current liabilities are due within one year, such as accounts payable and short-term loans. Long-term liabilities are obligations due after one year, such as long-term debt and pension fund liabilities.
Update your balance sheet monthly or quarterly to keep track of your financial position. For larger businesses, quarterly updates are common.
If your balance sheet doesn’t balance, check for errors in the classification of assets or liabilities or incorrect depreciation entries.
Tools like Ramp that integrate with popular accounting software are great for automating the balance sheet creation process, ensuring accuracy, and saving time.
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