How to Prepare and Analyze a Balance Sheet

The balance sheet is one of three financial statements that communicate the financial health of the business. The other two are the cash flow statement and the income statement.

What is a balance sheet?

The balance sheet is a snapshot of the financial position of a business at a particular point in time - as opposed to over a period of time. It shows what the company owns, what it owes and its net worth on the date when the balance sheet was prepared. Using a series of projected balance sheets, or "snapshots", the reader can determine the business's worth over a period of time.

illustration of 2 people and graph representing a balance sheet

The balance sheet is a snapshot of one point in time. Viewed over a period of time, an analyst can determine how the assets, liabilities and net worth of the business have changed.

Balance Sheet Example

balance sheet exampleNote that Assets are listed in the order in which they can be converted into cash (liquidity)

Assumptions to Balance Sheet Projections

pen, blank balance sheet and calculator

 When you prepare this statement, consider the assumptions underlying your financial plans and their effect on assets, liabilities and owners' and shareholders' equity (your investment plus accumulated profits).

  • Do accounts receivable reflect your current credit policy? For example, if your terms are net 30 days, are your customers paying within 30 days? Should you be allowing for 45 days in your plan to reflect real experience?
  • Do you have enough inventory to fill planned orders?
  • Have you adjusted figures for fixed assets and accumulated depreciation for reflect any plans for adding equipment or leaseholds?      • For long term debt, such as mortgages or debentures, what is the current portion of the principle payable each month? 
  • Do trade payables reflect your established arrangements with suppliers? For example, do you usually pay within 35 days?<br> 
  • Have retained earnings been adjusted monthly to reflect the planned profits or losses carried forward from the income statement?<br>
  • Are there any "hidden values" in your balance sheet? Be sure to inform your banker of market values of assets such as land, stocks, bonds and licenses.

Accounts Receivable

Accounts receivable is money owed to the business by customers who purchase goods on credit.

Name of Debtors Total amount Current amount 31 - 60 days 61-90 days Over 90 days
           
           
           
           
           
           
           
Total amount          
Percentage 100% % % % %

Accounts Payable

calculator illustration

Accounts payable is money owed to suppliers for purchases on credit. Accounts payable also includes money owed for other expenses like utilities or taxes.

Name of Debtors Total amount Current amount 31 - 60 days 61-90 days Over 90 days
           
           
           
           
           
           
           
Total amount          
Percentage 100% % % % %

Current Portion of Long Term Debt

 The current portion of long term debt consists of the amounts due on long and medium term debt over the next 12 months.

Mortgages and notes:

 
Loans from shareholders:  
Other loans:

 

Step by Step Instructions

Step 1: Calculate and List Fixed or Long Term Assets

What are fixed assets?

Fixed assets are those assets that lead to revenue.  These assets are not for sale and include leasehold improvements (for renters), land, buildings improvements, equipment, machinery, production machinery.

Cost basis for fixed assets

Fixed assets are listed at original cost less any depreciation. Original cost can include items such as installation, shipping and other expenses related to setting up the asset so that it can be utilized by the business.

What is depreciation?

Depreciation is the cost of wear and tear on an asset. It is deducted from the original cost of the asset.

Step 2. Compute total assets by completing the fixed and other assets section of the balance sheet.

Step 3. Calculate the liabilities and complete the liabilities section of the balance sheet.

Types of Liabilities

There are two types of liabilities:

  1. Current liabilities: accrued expenses (salaries and wages, accrued payroll taxes) , notes payable (to banks etc.), accounts payable, any long-term and creditor obligations due within 1 year 
  2. Long-term liabilities: any debts due after more than 1 year. This can include any obligations due to financing or loans.

Order of Liabilities

Liabilities are listed in the order in which they are paid.

4. Calculate and complete the net worth section of the balance sheet.

Net worth formula: Net Worth = Assets - Liabilities

Net Worth Definition

Net Worth is the assets left over when liabilities are deducted from assets. This is also known as owners equity.  Owners equity refers to owner investment plus profits less losses that are in the business.

How to Analyze a Balance Sheet

A balance sheet is analyzed by looking at a series of financial rations. The ratio of one number to another over time enables the analyst to compare a business to others in an industry and to look at trends in the business.

Current Ratio (Liquidity Ratio)

What is the current ratio?

A current ratio is defined as the # of times current assets exceed current liabilities.  It is a measure of business solvency.

Purpose of the Current Ratio

The purpose of the current ratio is to indicate if a business have enough current assets to pay anticipated current liabilities with some margin of safety. A good current ratio is considered to be at least "2".   A business can improve a current ratio by reducing current liabilities (pay down debt) or increasing the amount of current assets on hand (taking a loan due in more than 1 year, selling assets, rolling profits back into the business).

Have a strong current ratio may not always be a positive. It could indicate that a business does not have a profitable or productive way to invest any cash on hand.

Quick Ratio

What is the quick ratio? 

The quick ratio (or acid test) is a measure of a company's liquidity. It takes the most liquid assets and divides them by current liabilities.

"Quick" assets include:

  • bonds
  • stocks
  • cash
  • accounts receivable (all current assets excluding inventory)

Benchmark Quick Ratio

A quick ratio between .50 and 1 are considered to be satisfactory if the collection of receivables is as expected and does not slow down. The ratio indicates if a business can meet obligations if the business starts to slow down.

Debt/Worth Ratio

The debt/worth ratio (also called the leverage ratio) is a measure of how dependent a company is on loans (or debt financing) when compared to the owner's equity.  

Simply, it indicates what percentage of the business is owned and what percentage of the business is attributable to debt financing.

debt/worth ratio formula

Working Capital

Working capital is used to determine if an enterprise can withstand a downturn in revenue. Many lending institutions dictate the amount of working capital that has to be maintained during the course of the loan.

Working Capital Equation

Working Capital = Total Current Assets - Total Current Liabilities

Templates and Example

(PDF Download) Business Plans Guide


Resources

Projected Balance Sheet Template