Balance Sheet Explained

A Balance Sheet is indispensable to every business owner. Together with the Profit and Loss Statement and Statement of Cash Flows, the Balance Sheet forms a trio of key financial statements which should be prepared and reviewed on a monthly basis by every small business owner.

Here are the elements of a Balance Sheet:

Assets - Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Liabilities - Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Equity - Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest.

If you would like these Balance Sheet elements expressed in plain English, here they are:

Assets - everything a company owns (cash, inventory, furniture, etc.)
Liabilities - debts the company owes (loans, lines of credit, credit card balances).
Equity - company's owners' claims such as company stock and residual value of the company.

The main balance sheet elements are then further subdivided into sub-classes:

Assets:
Current Assets
Long-Term Investments
Property, plant and equipment
Intangible Assets
Other Assets

Liabilities:
Current Liabilities
Long-Term Debt

Owner's Equity:
Capital Stock
Additional Paid-In Capital
Retained Earnings

The distinction between Current and Long-Term liabilities is very important, especially when it comes to calculating balance sheet ratios.

The Equity section of the Balance Sheet will reflect the legal structure of the company. And so a Balance Sheet for a Sole Proprietor will have a different Equity section from a Balance Sheet for a Corporation. My financial templates are created with those differences in mind.

Once you are familiar with the building blocks of your balance sheet, the fun starts!

Now you can really start listening to all that the balance sheet is ready to tell you. And it has a story about so many aspects of your business!

So, how do we listen? How do we learn its language? By looking at its numbers - both in the absolute sense and, most importantly, in how they relate to one another. In accounting terms those relationships are called Balance Sheet Ratios.

Some balance sheet ratios can be calculated using only the Balance Sheet elements. Example of those ratios are: Current Ratio, Debt to Equity ratio, Acid ratio.

Other financial ratios require elements of both the Profit and Loss Statement AND the Balance Sheet. Examples of those financial indicators would be: Days Sales Outstanding, Inventory Turnover ratio, etc.

If you'd like to get started slowly, here is a sample Balance Sheet with links explaining in some detail every typical line item: Sample Balance Sheet.

The presentation of this balance sheet comes in a side-by-side format with assets on the left side and liabilities and shareholder's equity on the right side of the page.

Alternative format for presenting a balance sheet is vertical. In this case liabilities and shareholder's equity appear right below the assets.
If you are also patient and really, really interested, you may want to read through this article: Balance Sheet Analysis - Another-Secret-Revealed.