Finance guide: How to prepare a balance sheet

The balance sheet is one of the best resources to quickly understand the current health of a business. 

Read this blog to learn more about this vital financial document and how to prepare a balance sheet. 

Summary: 

• A balance sheet details a company’s assets, liabilities, and shareholders’ equity – three elements of the accounting equation. 
• Choose your reporting date, accurately list all three factors, and ensure they balance. 
• Download an easy-to-use template below as a guide. 

What is a balance sheet?

A balance sheet is a financial report that provides a snapshot of a company’s health. While an income statement covers a specific time period, balance sheets report a business’s performance at a specific date. 

Business owners and finance teams typically generate balance sheets monthly or quarterly to support planning, analysis, and fundraising. 

How the balance sheet works

The balance sheet, or a statement of financial position, is a critical decision-making tool because it details a company’s assets, liabilities, and shareholders’ equity. 

These happen to be the three elements of the accounting equation, represented by the following equation:

Assets = Liabilities + Shareholders’ Equity

Understanding these values shows a business's current finances and flags potential issues like rising inventories or poor working capital management.

Finance teams and business owners often pair the balance sheet with other financial statements to conduct fundamental analysis or calculate financial ratios that external stakeholders can use to determine investment potential and loan securing. 

Make sure your balance sheet always balances.

A strong sign that your balance sheet is well-structured and accurate is that it is balanced – it is in the name for a reason. 

“Balance” refers to the total value of the assets listed on the document equalling the combination of liabilities and shareholders’ equity. If the two sides of the equation don’t match, this is a common sign of an error, which we’ll cover later in this guide. 

Who prepares the balance sheet?

Balance sheets can be created and managed by a variety of people. For SMBs, balance sheets are usually prepared by the company owners, bookkeepers or fractional CFOs. Larger corporations might have a dedicated accountant or finance department.

How the balance sheet fits into the three-statement model

The balance sheet is one-third of the powerful trio known as the three-statement financial model: 

1. Balance sheet: How healthy your business is today.
2. Income statement: How profitable your business has been over a period.
3. Cash flow statement: How cash moves in and out of your business over time. 

Together, they create an overview of your business's overall economic status, crafting a comprehensive and interconnected financial narrative that enables owners to navigate challenges, pitch investors, and plan for the future.

Why businesses use balance sheets

The balance sheet is an essential tool used by executives, investors, analysts, and regulators to understand the current financial health of a business. 

Here are the top three reasons why they’re crucial: 

Reason 1: Financial reporting and analysis

A balance sheet is a critical tool in financial reporting as it gives a snapshot of a company’s liabilities, assets, and shareholders' equity, reflecting its overall economic health. 

Furthermore, it aids in calculating financial ratios like the acid test and debt-to-equity ratios, which offer insights into the company's liquidity and overall financial structure. Investors value these ratios for making informed decisions. 

Reason 2: Risk assessment 

Balance sheets serve as a dual-purpose tool internally. They allow businesses to assess risk by detailing all assets and liabilities, helping identify if there's excessive debt, insufficient liquid assets, or short cash to meet current obligations. 

Additionally, balance sheets provide the foundation for strategic decisions, guiding actions like cash flow management, equipment investment, or debt repayment, offering a roadmap for business growth and stability.

They can help understand answers to questions like: 

• Does the business have enough assets to cover our short-term debts?
• Is the business carrying too much debt compared to its equity or assets, putting us in a challenging position?
• Do we have sufficient liquid assets to capitalize on immediate opportunities or handle sudden expenses?

Reason 3: Capital fundraising

You won’t find a serious lender or investor that doesn’t require an accurate balance sheet as part of the due diligence process of securing a business loan or other private equity funding.

Investors want to understand the risks and potential upsides of investing in a business, which means they need a balance sheet to help paint a picture of the company’s financial health, creditworthiness, and ability to navigate short-term fluctuations. 

What’s on a balance sheet?

As mentioned previously, the balance sheet lists a company’s assets with its liabilities and equity as opposing sides of an equation.

1. The Assets section

In the balance sheet formula, 'Assets' refer to resources owned by a company that hold economic value. They are expected to provide future benefits to the business. 

Assets can be tangible, like machinery, property, and inventory, or intangible, like patents, trademarks, and copyrights. 

There are two asset categories tracked on a balance sheet: 

1. Current assets: Short-term assets that can be converted into cash within a year, such as cash and accounts receivable.
2. Non-current assets: Long-term investments that cannot be easily converted into cash, such as buildings, equipment, and land. 

Note: How asset depreciation is tracked on balance sheets and income statements depends on a company’s preferred reporting method. Check the balance sheet footer for more details.

2. The Liability section

Liabilities are what the company owes to others. They are the financial obligations or debts a company must pay and are settled over time through the transfer of economic benefits, including money, goods, or services. 

Liabilities can be broken down into: 

1. Current liabilities: Those due within one year (like accounts payable, wages, and taxes).
2. Long-term liabilities or non-current liabilities: Those due after one year (like leases, long-term loans, or deferred tax liabilities). 

3. The Shareholders’ equity section

Shareholders' equity, also known as owners' equity, measures a company's net worth and represents the residual interest in the company's assets after deducting liabilities. It's what would be left over for the shareholders if all assets were sold to pay off all debts. 

Note: A balance sheet is ‘underwater’ if the company has more liabilities than assets.

Key components of shareholder's equity include: 

• Common stock: Represents ownership in a company and a claim to part of the company's profits. Investors get one vote per share to elect the board members, who oversee major financial decisions made by management.
• Preferred stock: A type of equity that carries certain advantages over common stock, such as a priority claim to dividends and assets in case of liquidation. Note that preferred stockholders usually do not have voting rights.
• Retained earnings: This is the accumulated income a company has earned over its life that has not been distributed as dividends to shareholders but is reinvested into the business.
• Treasury stock: These are the company's shares that it has repurchased from investors but not retired. They typically don't come with voting rights or dividend privileges and don't count in the "outstanding shares" for earnings calculations.
• Additional Paid-In Capital (APIC): Also known as capital surplus, it represents the excess amount that shareholders have paid over the stock's par value. This generally occurs when the company first issues stock to raise capital.

Consistently positive shareholder's equity can signify financial health for potential investors.

Common reasons for incorrect balance sheets 

While creating a balance sheet, it is possible to encounter some discrepancies that lead to an incorrect balance sheet. Common issues include:

1. Incorrect or misplaced data: An error, such as entering the wrong number or placing a figure in the wrong category, can throw the balance sheet off.
2. Inventory errors: Mistakes in counting or valuing inventory can significantly impact the figures listed under current assets.
3. Exchange rate errors: For businesses operating in multiple currencies, miscalculations in exchange rates can lead to considerable errors.

Correcting these errors is where "balance sheet reconciliation" comes in. This is a necessary step in the financial close process where discrepancies are identified and corrected to ensure the accuracy of the financial statement. 

A precise balance sheet is crucial for internal analysis and for creating a reliable financial picture of the business for potential lenders and investors.

How to prepare a balance sheet in six steps

Here is a helpful guide for everyone from beginners to small business owners who want a refresher.

Step 1. Choose your balance sheet reporting date 

Since a balance sheet uncovers the financial health of your business at any given date, you must choose a specific date when starting your balance sheet. A balance sheet is typically prepared at the end of a set accounting period (e.g., every quarter or annually).

Step 2. List out your assets 

With this section of the balance sheet, create a list of line items in order of liquidity, starting with the most liquid assets (cash or items easily turned into money) and moving toward less liquid assets (like equipment or real estate). 

This includes:

1. Current assets – Can be converted into cash within one year (e.g., money, stock inventory, accounts receivables, and marketable securities).
2. Non-current assets or long-term assets – They take longer than a year to liquidate (e.g., property, plant, equipment, intellectual property).

Step 3. Record your current and long-term liabilities 

Now, move to liabilities. Similar to assets, list current liabilities before long-term ones. 

This includes: 

1. Current Liabilities: Debts or obligations due within one year (e.g., accounts payable, short-term loans).
2. Long-Term Liabilities: Obligations due after one year (e.g., long-term loans, bond repayments).

Step 4. Detail shareholders’ equity

Equity is what remains if you were to liquidate all assets to cover liabilities. 

This includes:

1. Owner’s Equity: The total amount invested by the owners (initial investments plus any additional investments).
2. Retained Earnings: All the profits that have been reinvested in the business rather than distributed to shareholders or owners 

Step 5. Format the balance sheet for easy reading

Now that all the data are categorized (typically using a spreadsheet or accounting software) align them into the balance sheet format that reflects the core equation: Assets = Liabilities + Shareholders’ Equity. 

Step 6. Ensure the balance sheet balances

Check if the Total Assets equals Total Liabilities and Equity. If you still need to, double-check your figures. A mistake could lie anywhere—typos, miscalculations, or omitted items.

Ensuring your balance sheet is accurate is essential to company operations. Just listen to The Secret CFO explain the painstaking steps they took to clean up the balance sheet in a previous role: 

The balance sheet was an afterthought. And this was a complicated, decentralized balance sheet across multiple ERPs. This was headed for accounting armageddon. It would take time to make the changes to the leadership, culture, and team. In the meantime, it was going to take some manual grunt work to avoid a disaster in the books. I started to show up to monthly balance sheet reviews. Even at levels well below my pay grade. This was no time to be precious. I needed to send a message to the whole finance team. Balance sheet hygiene was the first priority. We did things properly now. It took about twelve months to get the balance sheet cleaned up. But slowly the pendulum shifted. It took a bunch of personnel changes, and much more of my own time than I initially expected.

How to read a balance sheet

Reading a balance sheet involves understanding several key aspects:

Liquidity

This assesses the ability of a company to meet its short-term obligations. Higher liquidity indicates a greater ability to pay off debts as they fall due. Current assets and current liabilities sections in a balance sheet help evaluate liquidity.

Leveraging

This refers to using borrowed funds to invest with the expectation of higher returns than the cost of debt. Excessive leveraging or debt can be risky, and the balance between equity and debt in a balance sheet helps evaluate this.

Rate of Return

This shows the amount of profit or loss made from an investment. Comparing net income (from the income statement) to the total assets or equity on the balance sheet can provide a rate of return.

Efficiency

Efficiency measures how well a company uses its assets to generate profit. Ratios like asset or inventory turnover ratios (requiring information from the balance sheet and the income statement) can provide insights into a company's efficiency.

Balance sheet example: 

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Download: Balance sheet template

Here is a free Google Sheet template you can use as a basis for your balance sheet.

Essential tools for preparing balance sheets

Using the right mix of these tools can substantially streamline the process of preparing your balance sheet and improve its accuracy: 

Microsoft Excel

This versatile tool can help you calculate and organize financial data, allowing you to create customized balance sheets.

Accounting software

Accounting software like QuickBooks Online, NetSuite, Sage Intacct, and Microsoft Dynamics 365 Business Central can automate many aspects of balance sheet creation. 

What is important is that you maintain accurate reporting in your general ledger to ensure data integrity. 

Business bank account 

Your business's banking records are invaluable for tracking cash flow, assets, and liabilities. You want your business checking account to have a user-friendly interface so you can quickly download needed documents that will help you as you develop your balance sheet. 

Corporate credit card expense management software 

Many businesses use corporate credit cards to purchase business expenses or rely on employee reimbursements. 

In either case, corporate credit card expense management software can help manage and classify business expenses, accurately documenting current liabilities and assets. 

Accounts payable automation software

AP automation software can greatly simplify tracking and managing what your business owes, automating the process and giving detailed reporting that helps you quickly pull these figures for the balance sheet. 

Equity management software

Software like Carta can effectively manage, track, and analyze shareholders’ equity, providing a comprehensive picture of your business's equity capital.

FAQs: Balance sheets

Here are a few questions commonly asked about the balance sheet. 

What's the difference between the balance sheet vs. income statement?

The balance sheet, a snapshot of a company's financial health at a particular point, outlines what the company owns (assets), owes (liabilities), and the value held by shareholders (equity). It's a go-to document for understanding a company's liquidity and financial structure.

On the other hand, the Income Statement (or Profit & Loss Statement) shows the company's financial performance over a period. It details the revenues earned and expenses incurred, leading to the net income or loss. It's key to gauging profitability and operational efficiency.

While the balance sheet shows 'where we are,' the income statement reveals 'how we got there.'

What are the three main things found on a balance sheet?

A balance sheet consists of three primary components: Assets, Liabilities, and Equity. 

What is the balance sheet formula?

Assets = liabilities + shareholders' equity

How does the balance sheet affect the financial close process?

A well-balanced and comprehensive balance sheet drives a seamless, accurate, and efficient financial close process. Its accuracy prevents discrepancies that could impact other areas of this process. 

It helps spot differences and is used in reconciliation steps to confirm all transactions match up. Plus, it's critical for audit preparation, giving auditors a clear picture of the company's financial position.

Wrap-up: Simplify your SMB finances with Rho. 

Incorporating the balance sheet into your regular business operations can significantly boost your understanding of your company's financial trajectory, enable informed decision-making, and aid in securing capital. 

Yet, even with the help of advanced accounting or bookkeeping software, creating balance sheets can take time and effort.

Luckily, Rho's platform provides an all-in-one, fee-free solution that significantly simplifies balance sheet creation. Rho can save precious hours and streamline your financial operations by providing access to automated cash and spend management, banking, AP, and more. 

Get in touch with a Rho specialist to learn more today!

This blog has been reviewed by Karen Mei, Accounting Manager at Rho, for accuracy and completeness.

Rho is a fintech company and not a bank. Banking services provided by Webster Bank, N.A., Member FDIC.