How to keep a balance sheet

woman at laptopA balance sheet provides a snapshot of a company’s financial position at any given time, and is usually prepared at the end of a quarter or financial year. Some businesses find it useful to refer to their balance sheet on a monthly basis, however, particularly if they fear that insolvency may be a threat.

Keeping a balance sheet offers many benefits – it allows owners/directors to view the bigger picture of their business and take strategic or pre-emptive action as necessary. A balance sheet also allows for a more accurate valuation of a business, and can aid in obtaining external funding from banks and other lenders.

What does a balance sheet include?

A balance sheet summarises a company’s assets, liabilities and the amount of financial investment made by the owner or shareholders. These three aspects make up a balance sheet equation, the result of which can be used by potential lenders and other interested parties when making decisions about the company:

assets = liabilities + equity

In order to better understand the equation, you need to consider each of the categories, and the items that should be included within them.

Assets

Assets can be sub-divided into current assets, which can be converted into cash relatively quickly (within a year or less) and fixed assets, which hold longer-term value for the company (for more than a year), minus any depreciation.

Distinction is also made between tangible and intangible assets, where tangible assets are physical items owned by the company. Intangible assets, on the other hand, are not physical in nature, and include a company’s intellectual property, such as their domain name, as well as customer goodwill.

Fixed assets

Long-term assets include:

  • buildings and land owned by the company
  • fixtures and fittings
  • vehicles
  • computer equipment
  • goodwill
  • intellectual property including patents, trademarks and website domains

Current assets

Short-term assets include:

  • cash on hand and in the bank
  • debtors – money owed to the business by its customers or clients
  • stock and work in progress
  • pre-payments – such as rent, energy, or business insurance
  • short-term investments

Once the company’s assets have been identified and listed in the balance sheet, the next aspect to consider is its liabilities.

Liabilities

These represent what is owed by the company and, again, should be sub-divided into current (or short-term) liabilities which need to be paid within a year, and fixed (or long-term) liabilities that are due later than a year.

Long-term liabilities

Long-term liabilities include:

  • long-term loans, mortgages and HP agreements
  • pension payments
  • owner’s/shareholders’ capital and reserves – this represents how the business is funded, and for a straightforward business, would include the original cash investment plus any profits that have been retained

Short-term liabilities

Short-term, or current liabilities, include:

  • short-term loans and bank overdrafts
  • business credit card debt
  • trade creditors
  • accruals – goods or services used but not yet paid for by the business
  • creditors other than suppliers
  • corporation tax, VAT, PAYE and national insurance contributions outstanding
  • staff wages

When total liabilities are deducted from the company’s total assets, the resulting figure represents the owner’s or shareholders’ funds. This takes the original balance sheet equation, and uses it in a different way to isolate a particular aspect of the business.

The balance sheet is used as one of the indicators of insolvency, and if total liabilities exceed the total assets, then the company is said to be balance sheet insolvent.

What are the main benefits of keeping a balance sheet?

The balance sheet forms part of a limited company’s statutory accounts, and as such must be prepared annually, but it offers much wider benefits to a business than simple compliance.

Apart from being used to value a business and attract funding, a balance sheet:

  • Provides reassurance that the accounts balance as a whole, and that transactions within the accounting system have been reconciled.
  • Aids the decision-making process, enabling strategic changes to be made with more confidence.
  • Allows business owners and accountants to track a company’s spending, earning and investment, and identify any trends.
  • Provides an early warning of financial distress and the potential for insolvency.

In short, the balance sheet is an important document that, alongside other management information, can help a business to thrive.

About the author

Written by Keith Tully, partner at Real Business Rescue, part of the Begbies Traynor Group. Keith advises company directors and stakeholders on areas relating to cash flow, finance and insolvency.