Balance Sheets Explained
If you have been in business for a while, you will have almost certainly heard the term Balance Sheet. If you are new to business however, you may find yourself preparing a Balance Sheet for the first time. Here is a basic overview of a Balance Sheet and when you might need one.
What is a Balance Sheet?
A Balance Sheet is a financial summary and should give an overview of the financial health of your business. Like the name suggests, it essentially balances the what the business owns versus what it owes, leaving the overall value of the business or owner’s equity.
What is a Balance Sheet used for?
For business owners the Balance Sheet gives a snapshot of the financial position of the business. It can help guide their business strategy going forward. In New Zealand, the IRD require a Balance Sheet dated at the end of the financial year as part of completing an IR10 or Financial Statements Summary. Balance Sheets are also used by Finance Providers when considering lending or potential buyers if the business is put up for sale.
Common Balance Sheet Terms Defined
Assets
An asset is something tangible that your business owns. Assets such as brand or reputation would not be considered assets on a balance sheet as they do not have a tangible value.
Assets on a balance sheet are usually grouped into 2 categories – fixed assets and current assets.
Current Assets
These are assets that will generally last less than 12 months. Cash is considered a current asset as are things easily converted to cash such as stock or inventory.
Fixed Assets
These are assets that will remain with the business beyond 12 months. Fixed assets include items like equipment, buildings, machinery and vehicles.
Liabilities
A liability is an amount that you owe. Like assets these are generally grouped into two categories – current liabilities and long-term liabilities
Current Liabilities
This is an amount owed that needs to be paid off within the next 12 months. Taxes and accounts payable fall into this category.
Long term Liabilities
These are longer term loans and liabilities for example mortgages or lease payments for buildings or company vehicles.
Debt Ratio
This is the ratio of total debts compared to total assets. In some industries there is a maximum acceptable debt ratio, this will vary from industry to industry.
Owner’s Equity
The overall value of the business once the total liabilities have been subtracted from the total assets.
Technology and Balance Sheets
In days gone by a Balance Sheet was a document prepared by an accountant once a year. The invention of modern accounting software has made creating Balance Sheets far easier and enables businesses to create a Balance Sheet any time they choose. At Spectrum Accounting Xero is our preferred software for efficiency, accuracy and security of information.
Getting it Right
It is imperative that your Balance Sheet is an accurate reflection of your financial position. Leaving off just one asset or liability can throw out your results significantly. For expert, professional assistance with your Balance Sheet and other financial documentation, talk to the team at Spectrum Accounting.