A balance sheet is a snapshot of how your business is doing at a particular moment. It shows what your business owns and what it owes.
The balance sheet is crucial for understanding the financial health of a business, and looking at it will give both internal and external stakeholders an understanding of how your business is doing.
The balance sheet is one of three key financial statements alongside the income statement and the cash flow statement.
What does the balance sheet include?
It should include the following:
- Assets, including cash, outstanding invoices, property, and equipment
- Liabilities, such as incoming invoices, taxes, and loans
- Equity, includes share capital and retained earnings and represented the ownership interest in a company
The formula is simple: assets = liabilities + equity. This equation reflects the principle that everything a company owns—its assets—is either financed by borrowing—liabilities—or by the owners’ investment, also called equity.
The balance sheet helps investors, employees, management, and auditors assess how the business is doing and whether it can meet its short-term obligations.
Use it to check your bookkeeping
When it comes to accounting, all transactions are recorded in two places. For example, if you take up a loan for $2 000, your assets increase by $2 000. At the same time your liabilities, your loans, also increase by $2 000.
This concept of recording all transactions in two places is called double-entry bookkeeping.
Since the balance sheet is a statement of everything you have recorded, it should always work out to zero at the end of the fiscal year. In other words, your assets should be the same as the liabilities and equity combined.
If it does not balance to zero, you’ve most likely forgotten to record something in two places, in accordance with double-entry bookkeeping. Another common mistake is forgetting to record last year’s profit or loss against equity.
The balance sheet can also be used for reconciliation: to check that your bookkeeping is correct. For example, you can check that the amount you have in your bank account matches with what’s on the sheet. This is called a bank reconciliation.