Importance of balance sheets: A beginner’s guide

Most small businesses look at the Profit and Loss Statement regularly, but many don’t understand the importance of the balance sheet.

What is a balance sheet?

A balance sheet is a detailed list of a business’s assets, liabilities (or money owed by the business) and the value of the shareholders’ equity (or net worth of the business) at a specific point in time.

Assets are anything of value owned by the business, liabilities are debts owed to outside creditors or other parties and shareholder’s equity is the amount owed to the business owners.

It’s called a balance sheet because assets must always equal liabilities plus shareholders’ equity — the two sides balance out.

If you’re using online accounting software like MYOB Business, you can view your balance sheet in the ‘Reports’ dropdown list.

What is in the balance sheet?

A balance sheet helpfully lists, in a linear format, what your business owns and what it owes. It helps you to understand how much money your business would have left over if you sold its assets and paid off its debts. 

It lists: 

• Current assets – including cash in the bank, stock held and money owed to the business
• Fixed assets – including any buildings or property, plant and office equipment, cars or other vehicles
• Intangible assets – things like intellectual property, trademarks and patents or goodwill/brand value  
• Short-term liabilities – things you’d expect the business to to pay for within a year
• Long-term liabilities – things you’d expect the business to pay for over a longer period

Balance sheet classifications

Assets and liabilities are classified further to help you monitor your financial position. Both are broken down into “current” and “non-current” to show how soon they must be turned into cash (assets) or repaid (liabilities).

Current and non-current assets

‘Current’ refers to a period of less than 12 months, while ‘non-current’ refers to a time period greater than 12 months.

Current assets include cash and other items that will likely be turned into cash within a 12-month period, such as accounts receivable (monies owed from customers or debtors) and stock and other assets to be sold within 12 months.

Fixed assets

Listed after current assets are fixed assets, which are assets that will continue to exist in their current form (not cash) for more than 12 months. Fixed assets can include office equipment, furniture, tools, company vehicles, and more.

Current and non-current liabilities

Liabilities are listed on the balance sheet in order of how soon they must be repaid. Current liabilities — those that must be repaid within 12 months — are listed first. Then non-current liabilities (due after 12 months) are listed, followed by shareholders’ funds (equity).

Current liabilities typically include monies owed to suppliers, credit card debt and bank overdrafts. Non-current liabilities may include loans from external stakeholders.

Why is the balance sheet important to your business?

1. A snapshot of your business

The balance sheet provides a picture of the financial health of a business at a given moment in time — usually the end of a month or financial year.

It can tell you if you owe more money than what you currently have, the current value of your assets and the overall value of your business.

2. Spot trouble ahead

More importantly, if you familiarise yourself with using financial ratios, the balance sheet can provide warning signs so you can solve any problems before they destroy your business.

The balance sheet is a vital financial statement you should be reviewing regularly, as it changes with every transaction.

READ: Are you ready for the EOFY countdown? Time to get everything in balance!