No matter what business or industry you’re in, you would have encountered a balance sheet at some point. It’s one of the most important things for your business and it’s used for a variety of purposes.

So what is a balance sheet? Here’s an introduction to the basics.

Let’s get started!

What is a Balance Sheet?

A balance sheet, also known as a statement of financial position, tells you exactly that: the financial position of your company at any given time. Note that this is based on a specific point of time and not over a period of time. For example, as of January 31st or as of February 2nd. This is one of the financial statements that are produced on an ongoing basis.

Major Categories of a Balance Sheet

There are 3 major categories on a balance sheet: Assets, Liabilities and Equity

Assets = what you own
Liabilities = what you owe
Equity = the value of your company after paying off liabilities

Accounting Equation

Here is a quick lesson on the accounting equation:

Assets = Liabilities + Equity

Both sides must always equal, hence a balance sheet needs to balance.

Balancing rocks on a beach like a Balance Sheet

Here is an example of what a balance sheet looks like and follows the accounting equation:

sample balance sheet — Sample balance sheet

For example, how do you acquire an asset? You need to pay for it either through liabilities or equity.

Assets

As mentioned above, assets are what you have ownership over. They are typically split between current assets and long-term assets. Current assets are current because you can convert this to cash within one year (it’s more liquid) whereas long term assets are for longer than one year (it’s more illiquid)

Examples of current assets:

Cash and cash equivalents
Short Term Investments
Marketable Securities
Accounts Receivable
Holdback Receivable (if you are in the construction industry)
Inventory
Prepaid Expenses (expenses that you paid in advance of the period it’s incurred for)
Refundable Deposits
Work in Progress
Income Tax Receivable

Examples of Long-Term Assets:

Property, Plant and Equipment (PPE)
Machinery
Land
Equipment
Office Equipment/Furniture
Vehicles
Investments
Property Held for Development (if you are in real estate)
Deferred Tax Asset
Intangible Assets (something that you cannot see or touch)
- Customer Lists
- Trademarks
- Goodwill (usually if you bought or sold a company)
- Intellectual Property

Liabilities

As mentioned above, liabilities are what you owe. Similar to assets, they are typically split between current liabilities and long-term liabilities. Current liabilities are current because these are usually due within one year whereas long term liabilities are due for more than one year.

Examples of Current Liabilities:

Accounts Payable
Holdback Payable (if you are in the construction industry)
Accrued Liabilities
Line of Credit
Long Term Debt (on the portion that is due within one year)
Interest Payable
Income Tax Payable
Deferred Revenue

Examples of Long-Term Liabilities:

Long Term Debt
Mortgage Payable (if you are in real estate)
Deferred Tax Liability

Equity

As mentioned above, equity is the value of your company after paying off all liabilities.

Examples of Equity:

Common/Preferred Shares
Retained Earnings
Contributions
Distributions

Shining light bulb on a post-it on a tack board

The Importance of a Balance Sheet

Now that we went through some examples of the different categories of a balance sheet, how is this important for you?

Just to recap, the balance sheet summarizes all of the assets, liabilities and equity of your company at any given point in time. The ‘what you own’, ‘what you owe’ and ‘what the value of your company is’.

The balance sheet can be used to:

Determine the overall financial health of your company (some questions that are asked can be ‘do you have enough liquid cash to pay off your debts?’ or ‘how risky is your company?’ or ‘can you sustain operations into the future?’)
Secure loans (think creditworthiness, ‘do you have any security in case of default?’, ‘can you pay off the interest?’)
Secure equity funding (if investors want to invest in your company, they want to make sure they can generate a return on investment)
Benchmark (how does your company compare to competitors?)

Limitations of a Balance Sheet

Even though every business has a balance sheet and many stakeholders use this financial statement, there are inherent limitations to using this.

First, one of the most basic principles of accounting is the historical cost principle which means that all assets are recorded at the value of the original transaction. For example, if you purchased a computer for $2,000 then that would be the value you are recording on the balance sheet, even though that might be 2 years ago. In other words, ‘what did you pay for it?’

Your next question might be: ‘what if it increased in value?’ For example, you purchased land 2 years ago and now it appreciated by $100,000, unfortunately you can’t recognize this additional value since you didn’t purchase the land with the appreciated value.

Second, the balance sheet doesn’t capture things that have value but wasn’t purchased. Here are a couple of examples:

Your company has generated a huge following and loyal customers which means you created brand value
You have great employees and they helped you become an employer of choice
Your company has developed in-house the next generation software leading to a high valuation

Your Turn

Do you have a better understanding of what a balance sheet is and why it’s important?

If you found value from this article, make sure to sign up for our newsletter to get notified of a new blog!

At JTL CPA, we are Ontario’s virtual accounting firm. Our goal is to automate your accounting and bookkeeping processes in a way that increases financial visibility. Pair that with our value-added approach and tailored advisory solutions gives you the ability to make sound decisions from good data. Check out our website here: https://www.jtlaccounting.com.

Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.

The Importance of a Balance Sheet

The Importance of an Income Statement

Payroll Burdens: An Introduction