Last week's Workshop discussed the creation of an Income Statement, which shows profit or loss over a specific time frame. In today's Workshop, Jeffrey Moses outlines the step-by-step creation of a Balance Sheet, which gives a more complete picture of a business' assets and liabilities at any given point.
A Balance Sheet is often thought of as a "Complete snapshot" of a business on any specific day. Often the day chosen is December 31, or the last day of a company's fiscal period. A Balance Sheet may be created at any time, however. They are frequently used, along with an Income Statement, by banks and investors seeking information about a company for financing purposes.
Balance sheets are comprised of three main sections: Assets, Liabilities, and Equity. Assets are divided into two categories: "Current" and "Noncurrent."Current Assets usually are defined as anything that can be readily converted to cash (or exhausted in a year or less). Such current assets include: cash(savings, checking, short-term CDs), accounts receivable, and value of inventory. They also include raw materials used in manufacturing and notes receivable that mature in less than a year.
Noncurrent Assets include real estate owned(buildings, plants, land), machinery and equipment, and notes receivable that mature in more than a year. Certain intangible assets can also be included in Noncurrent Assets, such as: value of patents, value of goodwill, etc.
Each of the above two categories (Total Current Assets and Total Noncurrent Assets) should be totalled separately, then added together to determine the Total Assets.
Liabilities form the second main section of a Balance Sheet. Liabilities are divided into two categories: Current Liabilities and Long-Term Liabilities. Current Liabilities include items that are owed or will be owed within a year, such as: wages due, accounts payable, notes payable within a year, interest payments due, and taxes payable (including sales, state and federal taxes). Also included are the portion of outstanding debts that are due in less than a year.
Long-Term Liabilities include notes payable a year or more in the future, the portion of debts that will be due in more than a year, and bonds payable in more than a year. If your company has issued stock or has pension plans, you should consult with your accountant to determine if and how these long-term liabilities should be included on your Balance Sheet.
Each of the two categories for Liabilities (Current and Long-Term) should be totaled separately, then added together to determine Total Liabilities.
The third section of a Balance Sheet is Equity, which includes money invested in the business by owners, partners or shareholders. In the case of a corporation, money invested may include all stock held by shareholders. Also included in Equity are any reinvested profits, often called retained earnings. To calculate Equity, add invested money and reinvested profits, then subtract withdrawals.
A Balance Sheet does not calculate profit or loss. It is used to show a business' status at a given moment. Note that a Balance Sheet is, by definition, always "in balance." The Balance Sheet is defined as Assets = Liabilities + Equity. This formula works for Balance Sheets created for every company, from Microsoft to the corner newsstand.
Using a company's Income Statement and Balance Sheet in conjunction can result in some powerful tools for a business. One of the most commonly used is called Rate of Return on Total Assets. This is determined by dividing Net Income After Taxes (found on the Income Statement) by Total Assets (found on the Balance Sheet). The result is a percentage that tells a lot about a business. Ideally, this percentage should be higher than the rate paid for funds borrowed by the business. It should also be higher than the rate paid by conservative bonds or federal notes.
At some point, every business should create an Income Statement and a Balance Sheet. Consult your financial advisor or accountant for further details.
Some books that discuss Balance Sheets:
1) Financial Statements: A Step-By-Step Guide to Understanding and Creating Financial Reports, by Thomas R. Ittelson, Thomas R. Ittleson $15.99 February1998 Career Press
2) Understanding Balance Sheets by G. Thomas Friedlob, Franklin J. Plewa (Contributor) $34.95 April 1996 John Wiley & Sons
3) From Budgets to Balance Sheets: A Manager's Introduction to Finance (How to Book) by Bonnie Knapp, Karen Miller (Editor) $12.95 August 1997 American Media