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What is a Balance Sheet? Your Accounting Questions Answered

What is a Balance Sheet? Your Accounting Questions Answered

Balance sheets are an essential part of any business. They can be beneficial for retailers wanting to understand how much their store is worth.

This guide for beginners will introduce you to balance sheets. We’ll cover the following:

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What is a balance sheet?

A balance sheet is a financial statement that lists your business’s assets, liabilities and equity. It shows your financial position at any specific point in time.

Good to know

  • The purpose of a balance sheet is to give business owners and outside parties an idea of the company’s total value, financial health and ability to pay its debts.
  • Businesses usually prepare balance sheets quarterly or annually.


How can your business use its balance sheet?

The balance sheet gives you a clear picture of what your business owns and owes.

  • You can use the balance sheet to determine the business’s net worth to help potential investors value your business.
  • You can use it to obtain financing. Lenders usually want to understand if you can meet your financial obligations, and the balance sheet can help them with that.

Many business owners tend to look at their profit and loss (P&L) or bank statement to determine the financial health of a company. The balance sheet tells a better story.

“Your balance sheet allows you to see how much cash you have on hand. It tells you what you anticipate receiving from a sale you have already completed. And it tells you the value of your vehicles, buildings, and equipment over time,” said Earl T. Murray III, president and CEO of The Entrepreneur’s Accountants.


What are the three main balance sheet formats?

The most common balance sheet formats are comparative, vertical and horizontal. 

Let’s look at what each one can show you.

  • Comparative balance sheet: This balance sheet format provides a side-by-side comparison or a date-by-date comparison of a past and current balance sheet. “This can determine financial trends, strengths, or weaknesses and variances from one period to another,” said Mark Balog, a certified public accountant (CPA) and managing partner of Balog and Associate.
  • Vertical balance sheet: This is a single-column format of numbers starting with the asset line items, followed by the liability line items, and ending with the shareholder’s equity. “This is a more user-friendly way to compare the balance sheet of one company compared with another company, and more importantly, across industries,” he said.
  • Horizontal balance sheet: This format allows the company to provide more detail about the Assets, Liabilities, and owner’s equity by adding extra columns. “A horizontal balance sheet shows assets on the left and liabilities and shareholders’ equity on the right,” said Kirsha Campbell (CPA) of The Cash Lab.


What are the three sections of a balance sheet?

 Assets, liabilities and owner’s equity are the three main components of a balance sheet. 

Now, let’s look at what each one means.

1.   Assets

The resources that a firm controls are called assets, according to Andrew Griffith (CPA), an associate professor of accounting at Iona University. “These resources have future economic benefits for a firm, and the firm does not have to own those resources to include them on the balance sheet. They effectively have to control them for a significant period.”

Here are the assets listed on a balance sheet.

  • Cash: This account includes currency, coins and other funds that are readily available to be used in business operations.
  • Accounts receivable (AR): This account represents money customers owe your business for goods or services you have provided.
  • Inventory: This account includes raw materials, work-in-progress products, and finished goods awaiting sale.
  • Investments: This includes money that has been set aside for long-term purposes such as retirement or educational funds.
  • Property, plant and equipment (PP&E): This account includes land and buildings owned by the company, and any machinery, equipment or vehicles used in business operations.

Assets fall into two categories: tangible and intangible.

  • Tangible assets: Tangible assets are physical assets with an estimated monetary value. Think buildings, machinery, vehicles, furniture and fixtures. Tangible assets can be used in the production of goods or services or they can be leased to others.
  • Intangible assets: These assets have monetary value but cannot be seen, touched or held. Think of copyrights, trademarks or patents. Businesses often create intangible assets internally, and they can provide long-term competitive advantages.

2. Liabilities

Most people know this as debt, said Griffith. “A firm owes someone something. It has a financial obligation to satisfy. Unlike assets, which have different valuation methods depending on the type of asset, liabilities are fairly transparent,” he said. “Liability balances tend to appear on the balance sheet as either the actual amount owed or the present value of the future amount owed.”

Current liabilities on the balance sheet may include:

  • Short-term debt: This is any amount of money your business owes that is due within one year. This can include loans, lines of credit and credit card balances.
  • Interest payable: Interest payable is any money your business owes in interest charges for loans or lines of credit. Interest payable will appear as a liability on your balance sheet until the loan or credit line is fully repaid.
  • Accounts payable (AP): This covers your unpaid bills. This is the money you have yet to pay suppliers for goods or services they have already delivered. Accounts payable will appear as a liability on your balance sheet until the bill is paid in full.
  • Income taxes payable: Most businesses are required to pay income taxes to the government every quarter. These taxes can include federal, state and local taxes.
  • Wages payable: Wages payable is any money your business owes to its employees for work that has been done but not yet paid for. Wages payable will appear as a liability on your balance sheet until the employees are paid in full.

Balance sheets also contain long-term liabilities. For example:

  • Mortgages: Retail businesses will often have a mortgage payable if they own their store’s building or commercial unit. A mortgage payable is a long-term loan you have secured with real property (such as land, buildings or equipment). Mortgages typically have terms of 15 to 30 years and are paid in installments.
  • Capital lease obligation: A capital lease obligation arises when a retail business leases land, buildings or equipment from another party for longer than one year. Capital leases are usually recorded on the balance sheet as long-term liabilities.

3.   Equity

“[Owner’s equity] includes the money the owner has invested into the business (owner’s investment) and funds taken from the business (owner’s drawings). The net income for the year becomes retained earnings and is listed in owner’s equity,” said Barbara Cross, a New York-based small business bookkeeper.

Larger retail businesses can have many owners—such as shareholders. In these instances, shareholders’ equity represents the funds available to the company. This includes money that has been invested in the company by its shareholders, as well as any profits that have been reinvested back into the company.

Retained earnings are the profits a business has not paid out as dividends to shareholders. For smaller retailers, these are the profits you have not drawn out as the owner.


Balance sheet vs. income statement: what is the difference? 

Balog provided this helpful table to demonstrate the key differences between a balance sheet and an income statement.

Balance sheet Income statement
Time frame The balance sheet summarizes the financial position of a company at a specific point in time. The income statement provides an overview of the financial performance of the company over a given period.
Key items It includes assets, liabilities and shareholder’s equity, further categorized to provide accurate information. It includes revenues, expenses and gains and losses realized from the sale or disposal of assets.
What it shows It helps assess financial health using ratios such as current ratio, debt-to-equity ratio and return on shareholder’s equity. Ratios such as gross margins, operating margins, price-to-earnings and interest coverage paint a picture of financial performance.
Who can use it Investors and lenders use it to determine creditworthiness and availability of assets for collateral. Management, investors, shareholders and others use it to assess the performance and future prospects of a business.


Striking the right balance 

Retail businesses should keep tabs on their balance sheets and work toward having more assets than liabilities. This can make your business a more attractive investment opportunity. But above all, good balance sheet management can help you remain solvent in the long run.

A POS system like Lightspeed Retail can sync with your accounting software to help you maintain an accurate balance sheet. Talk to one of our experts to discover what Lightspeed Retail can do for your business.

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