Balance sheets: the basics
Do all businesses need to draw up a balance sheet? No, this is a widespread misconception, because not all entrepreneurs need to keep complete double entry accounts. What the best accounting practice for you is depends on a number of factors, like sales or activity field. Here, you will find out what generally needs to be taken into account when it comes to balance sheets, and whether you need to concern yourself with one.
What are the advantages and disadvantages to drawing up a balance sheet?
Time can be a scarce resource. Creating a balance sheet is unfortunately more time consuming than preparing a simple income surplus calculation. However, at this point it is important to clarify that you are only legally obliged to publish a financial statement if you own a publicly traded company. Financial statements consist of a balance sheet, an income statement and, if necessary, an appendix with explanations. If you are required to prepare financial statements, you should draw up two balance sheets per year: an opening one at the start of the fiscal year, which has assets and liabilities clearly compared, and a final balance sheet at the end of the year. It is important when preparing these to adhere to the United States Generally Accepted Accounting Principles (US-GAAP) to ensure best practice.
Although preparing balance sheet can be annoying, it does have some advantages:
Advantage of a balance sheet
Disadvantage of a balance sheet
Transparency: A balance sheet brings clarity to a company’s financial situation. It is easy to lose track of things yourself, especially when your company is growing quickly. Balance sheets also come in handy when seeking external funding from banks or outside investors. Proof of healthy finances is paramount for anyone taking a risk on your business. A balance sheet helps with this.
Who is required to prepare a balance sheet?
Any company operating in the USA with shares available for purchase to the public is required by law to prepare a balance sheet and issue financial statements. If a company is privately owned, then they are not required to make this information public. The key aspect here is public vs private: it does not matter whether the company is a small business, a large corporation or a sole proprietorship. If the company is publicly owned, then they must make their financial information publicly accessible. If they are privately owned, then they are not obliged.
Voluntarily preparing a balance sheet
Even if you are not the owner of a publicly traded company, it may still be in your interest to prepare and release financial statements including balance sheets. Preparing a balance sheet ensures that you have a full, accurate picture of your company’s’ finances at a given time. This can be extremely helpful to business owners who get caught up in the minutiae of day-to-day tasks and perhaps miss the bigger picture. Small business owners in particular often do not realize that their business is perhaps not as profitable overall as they expected, since they are dealing with small transactions on a day to day basis. Certain liabilities and depreciating assets, particularly real estate, may create an unhealthy financial situation for your business without you even realizing. Creating a balance sheet is a helpful step in creating accurate, comprehensive accounting records for your company.
Having an up to date balance sheet can help you recognize priorities within your business. A balance sheet will include any outstanding debts owed by or to you, and can remind you to focus on these or any other areas of worry that show up in the balance sheet report. Maintaining a cash flow and keeping debts under control are paramount when running a business. Balance sheets can help you adjust any business practices that aren’t serving your interests fully.
Aside from personal knowledge, creating a balance sheet can be beneficial if you decide to seek external investment in your company. Many banks, financial incubators and private investors want to see a complete overall picture of a company’s finances before putting their own money on the line. They use the information provided in a balance sheet to calculate financial ratios and determine whether your company is likely to be profitable, as well as whether or not you will be able to repay them. A balance sheet is a good way of providing this information, and has become the common standard request for investors.
Creating your balance sheet
While it is certainly possible to create your own balance sheet, if you are new to accounting and running a business, then consulting a tax professional is a good option. Hiring an accountant for a one-time job will be far less expensive than the penalties you might face if you publish incorrect financial statements.
If you are confident in your skills, then the SBA website has more information, and provides sample templates for a balance sheet.