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Understanding the balance sheet

A balance sheet is a snapshot of your business’ financial condition at any given time and is a good indicator of how stable your business is. As a small business owner, preparing a balance sheet will help you to keep track of your spending and earnings and in turn avoid financial problems. This article gives you an overview as to the mechanics of a balance sheet and the information and records you need to prepare one.

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Video: What is a balance sheet?

A balance sheet is one of the major financial statements used by a business owner or accountant. Also referred to as the statement of financial position, this document shows the value of a business in terms of its asset and its liabilities i.e everything the company owns and owes.

How do I calculate the net value of my business?

The net value of a business is calculated by taking the total assets of a business (goods and resources owned by the business), less its total liabilities (debts of the business).

Total assets (things the business owns) include:

  • fixed assets
  • and current assets.

Examples of assets include

FixedCurrent
Motor vehiclesCash
Computer equipmentStock
MachineryDebtors (customers that owe you money)
Land and buildings 

Total liabilities (money owed to the business or money the business owes) include:

  • short term liabilities
  • and long term liabilities.

Examples of liabilities include

Long termShort Term
MortgageCreditors (suppliers you owe money to)
LoansVAT (the VAT you owe to HMRC if you are VAT registered)
SalaryPAYE and NI (if you employ staff) 

 

What are current assets and current liabilities?

Current Assets

Current assets are amounts that a business can reasonably expect to convert to cash within one year.  Examples of currents assets include:

  • Cash and bank account balances
  • Accounts receivable – customer invoices
  • Stock – though slow moving stock may be difficult to turn to cash readily
  • Prepaid expenses – costs that have been paid but good or services not yet received
  • Interest receivable
  • Other amounts receivable in the short term.

Current Liabilities

Current liabilities are a business’ debts or obligations that must be paid within one year.  Essentially, these are amounts due to suppliers and other creditors, including:

  • Accounts payable – supplier invoices
  • Amounts payable on loans with a year
  • Accrued expenses – costs that have been incurred but are yet to be invoiced for
  • VAT and other taxes payable 
  • Customer deposits – if a customer pays in full before completion of their order
  • Interest payable.

Current liabilities are generally paid by liquidating current assets, for example by receiving payments from customers, but may also be settled through replacement by other liabilities such as short term loans.

Download: Balance sheet template

Click on the download button below to access and use this balance sheet.

This spreadsheet shows the amount of assets vs the amount of liabilities. Once asset and liability values are entered into the relevant cells in the spreadsheet, the graphs are automatically populated to visually show the difference between the assets and liabilities. 

Download: Please login or register to get your download.

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How often are balance sheets prepared?

Balance sheets can be prepared as regularly as a business would like. The more frequently they are prepared the more up-to-date the business owner is on the financial position of his business.

Balance sheets are different to profit and loss accounts in that they are not prepared for a given period but are instead prepared at a certain date e.g a balance sheet at 31 December would show what the business is worth at that date.

When annual accounts are prepared by an accountant, they usually prepare a profit and loss account and a balance sheet as part of the year end procedures.

What is a balance sheet used for?

For a sole trader business, the main user of the balance sheet will be the small business owner. He/she will use it to gain an idea of the liquidity of the business (the amount of cash a business has on hand or how quickly it can generate cash) and the position of the business overall – i.e how well the business is doing. 

Where the owner seeks additional finance, say from a bank for example, the bank are likely to want to review the balance sheet of the business to assess whether the business is a good or risky investment. 

For a larger company, a balance sheet is used by investors to help them decide whether they want to invest. It also used to value the share price. 

What information do I need to prepare a balance sheet?

The information and records you need to prepare a balance sheet could include any of the following. Login to save this checklist to your profile for future use. (To register to join and enjoy the benefits of membership click on the link at the top right of the page. It will only take a few minutes to create your profile).

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