A balance sheet (also known as a statement of financial position) is a summary of a company's financial balances at a specific point in time.
Usually prepared at the end of the financial year, it shows the company's assets, liabilities, net asset position and equity which represents your financial position. This shows you the overall financial 'health' of the company at that point.
What Does It Balance?
To put it simply, it's called a balance sheet because your assets must equal your liabilities plus your equity. Everything must balance out!
Listed on one side of the balance sheet is everything the company has - its assets. This can include current assets such as cash, accounts receivable and prepaid expenses for future services. There are also "fixed assets" that include property and equipment as well as investments, intangible assets, and biological assets like plants and animals.
On the other side of the balance sheet are the liabilities like accounts payable, provisions for employee entitlements, owed taxes, loans owing, and unearned revenue, as well as owners' or shareholders' equity.
When added all together, the liabilities plus the equity should equal the total assets. When a company is in real trouble, the company owes more than it owns, which shows up as negative equity on the balance sheet.
Comparing Over Time
If you are an individual or small business, your balance sheet is likely to be simple, but still quite useful.
Using the balance sheet, you can review the amount and composition of assets, debt, and working capital of your business and use that information to judge your company's strengths and capabilities. You will also get a sense of your relative liquidity - the amount of cash you have on hand for short-term expenses - and how easily you'll be able to satisfy your long-term and short-term debts.
The real value, however, is that the balance sheet is a "snapshot" of your company's financial condition at the same point in time each year. Once you have multiple balance sheets you can compare the worth of your business over time and establish goals and plans for your future.
Who Uses Balance Sheets?
Although sole traders and partnerships don't have to lodge a balance sheet with their annual return, it's a good idea to prepare one anyway.
It may seem like a lot of work, but if you're using accounting software like Xero, a balance sheet can be generated with a few clicks of your mouse! Of course, all public and large proprietary companies are required to prepare and submit a balance sheet with their annual formal financial report to the ATO.
Want to know more? Next week we'll tackle how to interpret your balance sheet!