Business essentials explained: Balance Sheet
Updated: Jun 7, 2019
Want to learn the accounting essentials to run your business successfully?
This FinanceWise blog will give you a quick overview of the accounting basics helping you understand the definitions commonly used in business. Being aware of the technical definitions helps you better understand management information, management accounts and statutory accounts which you will have to present to Companies House, HMRC and perhaps banks or investors. Apart from external stakeholders, it’s also useful to help you run your business and give you peace of mind by understanding the different elements of your business, who you owe money, who owes you money and how much money your business has in free reserves.
The Basics - Understanding Assets, Liabilities, and Equity Before you set up your bookkeeping system, you need to understand the firm's basic Balance Sheet accounts, such as - assets, liabilities, and equity. These are different than your Profit and Loss accounts. Below you can see the difference between Balance Sheet, P&L and Cash Flow Statement.
Assets can be best described as what the company owns, which can be e.g. inventory, cash, buildings, accounts receivables, intellectual property or financial products. Liabilities are the things the company owes such as what is owed to suppliers (accounts payable), bank and business loans and mortgages. Equity is the ownership a business owner, and any investors have in the firm. The equity on the balance sheet shows the share capital of the company and the profit or losses of prior periods.
Balancing the Books An accurate balance sheet is always in balance, hence the name. There is a key formula to make sure your books always balance. That formula is called the accounting equation:
Assets = Liabilities + Equity
The accounting equation means that everything the business owns (assets) is balanced against claims against the business (liabilities and equity).
Assets: If you look you look at the format of a balance sheet, you will see the asset, liability, and equity accounts. Asset accounts usually start with the cash account, accounts receivable, inventory accounts receivable, and fixed assets such as land, buildings, and plant and equipment are listed. Firms also have financial assets, such as investments in other companies and intangible assets such as customer goodwill and intellectual property.
Liabilities: The liability accounts on a balance sheet include both current (less than 1 year) and long-term (over 1 year) liabilities. Current liabilities are usually accounts payable and accruals. Accounts payable is what the business owes to its suppliers, credit cards, and bank loans. Accruals will consist of taxes owed to HMRC and any costs which have been incurred for which you haven’t yet received an invoice.
Equity: The equity accounts include all the claims the owners have against the company. The business owner has an investment, and it may be the only investment in the firm. If the firm has taken on other investment, that is considered here as well.
Should I set up the Balance Sheet for my business?
For a starting business, it is a good idea to have an accountant to do your first balance sheet — particularly if you are new to business accounting. A few hundred pounds of an accountant's time may pay for itself by avoiding issues with the tax authorities. You may also want to go over the balance sheet with your accountant after any major changes to your business or when you can afford to hand over the accounting to your accountant.
Accounting software for Balance Sheets
Balance sheets are easy to do if you use accounting software. Accounting software designed for small businesses can keep track of all your accounting information and generate balance sheets, cash flow statements, and other reports automatically as needed.
Example of BMW's P&L, Balance Sheet & Cash Flow Statement and how they relate among each other:
The important aspect of the balance sheet is that the debit and the credit side, or asset and liability/equity side are in balance. So if you purchase inventory your assets will go up, but on the credit side also your accounts payable account will go up with the same amount. Therefore both sides remain in balance.
The balance sheet will give you a quick overview of what your business owns, what it is owed and what it owes to stakeholders.
If you’re not sure how to set up your balance sheet for your business or want professionals to set it up and maintain your bookkeeping and accounting, FinanceWise will help you find the right accountant for your business. FinanceWise will save you time and energy in finding the best accountant which understands your business and business needs.