- Writing a Business Plan
- Financial Statements
- Business Forecasting
- Business Checklist
THE BALANCE SHEET
The Balance Sheet is a statement used to determine the financial strength and weakness of a business. It lists everything a company owns and everything a company owes at a specific point in time. For example, an existing business may develop a balance sheet on July 8, 200X in order to see what it owns and owes on that specific date. The same company may develop another balance sheet on August 20, 200X to view the items it owns and the money it owes on that date. The company then can compare the two Balance Sheets (on July 8 and on August 20) to determine whether their financial position is improving. If, however, you are not an existing business owner but are planning on establishing a business, you will be required to construct annual forecasted balance sheets for three years into the future. This will enable you, as a potential business owner, to estimate the items your business anticipates to own in each of the three years as well as how much your business anticipates to owe in each of the three years. By developing a forecasted annual balance sheet for three years into the future, you and investors will be able to determine if your proposed business provides an opportunity.
Whether you are an existing business owner or an aspiring entrepreneur, it's imperative to fully understand the components and principals of the balance sheet. In this section, we will discuss the components and principals of the balance sheet. The following information will not show you how to develop forecasted balance sheets; this is discussed in the section entitled Developing Your Own Forecasted Financial Statements. Be sure to read this section before attempting to develop your own forecasted balance sheet!!!!! Lets get started.
FOUR COMPONENTS OF THE BALANCE SHEET:
The balance sheet consists of four main components, namely; the Heading, Assets, Liabilities, and Equity. The Heading depicts the name of the company, the name of the statement and the date at which the account balances apply. Assets are items that have economic value to a company. Liabilities are items that have an economic burden on the company - usually items a business owes to other businesses. Equity consists of all the investments made into a company over the years - usually in the form of capital or shareholder's investments and retained earnings. One very important thing to remember about the Balance Sheet is this:
THE ASSETS OF ANY BUSINESS MUST ALWAYS EQUAL THE SUM OF THE BUSINESSES' LIABILITIES AND EQUITY.
ASSETS = LIABILITIES + EQUITY
This is how the Balance Sheet received its name. The Assets balance with the Liabilities and Equity. Lets now separately explain the four major components of the Balance Sheet. To do this we will use the following balance sheet example.
Balance Sheet Example:
|The TOY Company
As of December 31, 200X
|Accounts Receivable||$ 5,000|
|Prepaid Fire Insurance||$ 1,200|
|Total Current Assets||$28,880|
|Office Equipment (2yr life)||$12,500|
|Less Accumulated Depreciation||$ 6,250|
|Net office Equipment||$ 6,250|
|Building (5 year life)||$22,500|
|Less Accumulated Depreciation||$ 2,250|
|Total Fixed Assets||$26,500|
|Income Taxes Payable||$ 5,676|
|Short-Term Loan Payable||$ 5,179|
|Total Current Liabilities||$23,109|
|Mortgage on Building||$19,757|
|Capital - Donald Sutherland||$12,514|
|TOTAL LIABILITIES & EQUITY||$55,380|
As you can see the Asset = Liabilities + Equity ($55,380 = $42,459 + $12,921). The following assumptions also are needed for our example. Be sure to read all assumptions since they will be referred to as we explain the components of the balance sheet.
Assumptions For Our Example:
Donald Sutherland is the sole-proprietor of The Toy Company. He invested his life savings of $10,000 into his business. The Company buys preassembled wooden toys from a supplier in Maine and sells them to end consumers (you and I). Donald registered the company on January 1, 200X and has been operating it since then.
Today's date is January 10, 200Y. The above Balance Sheet, however, shows the Toy Company's financial position on December 31, 200X
On January 1, 200X the company purchased office equipment valued at $12,500. The equipment consists of two computers, a fax machine, and a mobile photocopier. Donald's accountant suggested these item be pooled into one asset account called Office Equipment.
On July 1, 200X, The Toy Company received a 10 year, $22,500 loan to purchase a building. The building will be used to sell the company's preassembled toys.
Donald's accountant suggests the building has a useful life of 5 years and will be depreciated in equal amounts per year over these 5 years. Therefore, the building will depreciate $4,500 per year ($22,500 divided by 5 years = $4,500 per year). Lets also assume, the accountant suggests the office equipment pool of assets has a useful life of two years and will be depreciated in equal amounts per year over these two years. Therefore, depreciation expense and accumulated depreciation on the office equipment will be $6,250 per year ($12,500 divided by 2 years = $6,250 per year). The asset's estimated value, after their useful lives have expired, is assumed to be zero. Note: The useful lives have been set only for presentational purposes and should not be used as guidelines.
On July 1, 200X, The Toy Company purchased fire insurance on its building and its inventory of toys. The insurance company quoted a yearly rate of $2,400. The insurance contract called for a 1 year payment to be made in advance.
The company applied for and received a short-term loan of $7,000 on August 10, 200X from a local bank.
The company allows its customers to buy products on credit. The credit terms established by the Toy Company requires customers to pay within 30 days of the purchase date. Those customers, not paying within the 30 days, will be charge 2 % interest.
The Toy Company has established a credit rating with its supplier which allows them to pay for each order of preassembled toys within 45 days. Also, Donald has set up charge accounts with local vendors(merchants) which allows him to pay for the company's general office supplies within 45 days.
The Net Income before taxes for the Toy Company in 200X (from January 1 to December 31) is $14,190. Donald's accountant determined a tax rate of 40% would apply to the net income before tax. Therefore the income taxes to be paid will be $5,676. As of December 31, 200X, the tax obligation has not been paid and therefore is considered an income tax payable. The company's 200X Net Income After Tax is $8,514 ($14,190 - $5,676 = $8,514).
Donald withdrew $500 cash each month from the business to pay his personal living expenses. Therefore, during the year, the total amount he withdrew was $6,000 ($500 x 12 months).
This concludes the assumptions section of our example. Now lets examine each of the four Balance Sheet items and components:
Balance Sheet Items and Components:
For a conclusion, including a discussion on how the Balance Sheet may relate to your particular situation, please click HERE. Below provides you with examples of various balance sheets. Notice the four components exist in each example.
EXAMPLES OF THE BALANCE SHEET