Balance Sheet from a Small Business Owner’s Perspective

You don’t need to be an accountant or be a part of an accounting team to know the term ‘balance sheet’, it's a generic term in the world of business. However, knowing the term and knowing what it actually is, are two different things, so let’s dig a little deeper.

As a new business owner or small company owner, you may feel a balance sheet is something that’s not too important or it's something you can ‘figure out later’, but knowing ‘balance sheet basics’ and ‘creating a balance sheet’ are vital in building a successful company. Before we get into why a balance sheet for small business accounting or any businesses are important, let’s go back to the basics.

First, we need to know:

What exactly is a balance sheet for a small business?

Just like most topics nowadays, if you go online and look it up, you're going to find a lot of technical, complicated answers that will scare you into giving up your quest for knowledge. So, simply put, “A simple balance sheet for small business is a statement of assets, liabilities, and equity of a company” which are listed in three columns because it works on the double-entry method. Let’s stop here for a minute and break that down further as we take a look at what each column contains and means.

Here comes the formula for balance sheet

In the first column or left column you list your ‘Assets’:

What is an Asset?

The short way to define it according to some experts is “assets are things that add value to your company and increase your company’s equity”. If that isn’t clear, you can classify them as what your company owns that can eventually be turned into cash or cash equivalents. These are things that also have economic value and can be exchanged or sold. Furthermore, assets are divided into two types:

Current assets:

• Current assets are things that your company owns that can be consumed within a year, for example:

• Cash and cash equivalents

• Marketable securities

• Prepaid expenses

• Accounts receivable

Long-term assets:

These are things that continue to be productive for your business over a longer period of time, for example:

• Capital

• Shares

• Stock

• Investments

• Inventory

• Office equipment

• Machinery

• Real estate (which is property or land owned)

• Company-owned vehicles

• Trademarks

• Patents or other intellectual property

If you take a moment to go through the list, it becomes pretty clear on what assets are. Moving on to the next column in a balance sheet.

The column in the middle is for your Liabilities. It will give you a fair understanding of what is a liability in accounting

What is a Liability in Accounting?

Liability holds an immense importance in balance sheet formulas. it is basically what you owe; the obligation of your company and can be divided into two categories which are: current liabilities and long-term liabilities. Current liabilities are ones due immediately or within the coming year, whereas long-term liabilities won’t be due for another year at least. For example, if you have a 35-year mortgage on a building owned by your company, next year's payments that you have to make, will be listed under ‘current liabilities’, while the remaining amount to be paid will be your long-term liability. Here are a few examples of what is liability in accounting-:

• Notes Payable

• Interest Payable

• Accounts Payable

• Salaries Payable

• Accrued Expenses Payable

• Wages Payable

Lastly, we move on to Equity.

What is Equity?

Equity is the ownership of any asset after all liabilities associated with the asset are cleared. For example, if your company owns property worth Rs250,000, but you owe Rs100,000 on that property, the property represents Rs150,000 equity.

Now that we’ve got a picture of formula for a balance sheet, you may be thinking “It seems like a lot of numbers and I can’t do that” or “I’ll get an accountant to do it”.

As a “non-accountant” or someone who has limited knowledge of accounting, it’s natural to think in that manner, but, do not fear, there is no need to do a course on accounting. Even if you hire an accountant to do the work for you, “knowledge is power” and knowing how a balance sheet works as a business owner could tip the scale in your favour. And here's how you do that:

Balance Sheet Formula:

There is a formula for balance sheet available

Assets = Liabilities + Shareholders' Equity

We now know that a balance sheet is based on the double entry accounting method and based on the equation above, both parts must equal each other or balance each other out.

If a balance sheet has got to balance, the total in your ‘assets’ column should equal the total in your liabilities and shareholders' equity column. This means, your company assets, or the means you use to operate the company, are balanced by your company's financial obligations, along with the investment brought into your company and all of the company’s earnings.

Now, Moving on to the real question: why is a balance sheet important?

The Importance of a Balance Sheet

To understand the importance of a balance sheet, look at it this way: A balance sheet is to a company as a report card is to a student. A school report card contains details on various subjects and how a student is coping with said subject. You have columns with marks scored in each subject and a grand total that tells you how the student fared through the year. The numbers speak for themselves! All you have to do is read the report card and it becomes clear as to what the student’s strengths and weaknesses are; then the parents and students have to come up with a plan to fix the areas where the score is bad and work on it.

It’s pretty similar for business owners, a balance sheet is your ‘report card’
When it comes to investors, you have got to let your report speak for you. You may have seen new business owners and small business owners run around trying to get investors to pay attention. They write letters, send emails, talk for hours trying to convince these people, promising them that their investment is “going to pay off” and “will be a good idea” but rarely do serious investors pay attention to essays or lengthy articles/appeals, they want cold, hard facts, not promises and that’s where a balance sheet does the talking for you, just like a report card, all you need to do is hand it them. It also saves you from unnecessary ‘brown-nosing’; investors/shareholders can go through it at leisure and take necessary steps.

I read recently that one of the most successful investors of our time ‘Warren Buffet’, goes through stacks of balance sheets from various companies and scrutinizes them in order to find a good investment. Although he plays in the big league, it’s a lesson of its importance of balance sheets.. Now onto the final question:

How will a simple balance sheet for small business help my business?

This question is closely related to the previous one since we know why a balance sheet is important. it's good to know, what more it can do for your business apart from being an ‘investor's guide’

A balance sheet for small business shows you the big picture. When you’re running a business day to day, it’s easy to get focused on whether cash is coming in or not, whether you can pay your bills, and if you’re making payroll. A balance sheet goes beyond this short-term view to show your business’s progress over time.

When you compare your assets to your liabilities, it becomes abundantly clear, whether your business can cover its short-term obligations or not. If your liabilities are more than your balance, the business may require additional capital investment from an investor or financial organization.

However, a simple balance sheet for small business can also show you when your debt levels are dangerously unsustainable. If you have too much debt on your balance sheet, you will probably default on payments or eventually declare bankruptcy. It’s an early warning system, kind of like a ‘lighthouse’ to your business; warning you or showing you danger in advance

Another benefit is that it could help you secure a loan. Just like how it shows investors your track record, it could do the same with other financial institutions. It shows them that you have a record of managing assets and liabilities responsibly. It clearly shows lenders that you repay your debts on time.

It helps you understand the value of your business. You may not be planning to sell your business or company anytime soon but having an idea of its value (that is, the owners’ equity) can give you deep insight into your options for its future.

According to a study “29% of small businesses fail because they run out of cash” and most of the problems can be traced back to not having or maintaining a proper report on finances.

To conclude, preparing a report and understanding your company’s financial statements are a vital part of being a small-business owner. We have established beyond doubt now, that a balance sheet for small business is particularly important in making sure both you and your stakeholders are kept informed of your financial standing. When you keep this information updated, it can help you make better decisions at the management level. It could improve your business’s operational efficiency, borrowing, and overall financial health. So, a simple balance sheet for small business has got to be your number one priority.