How to Build a Balance Sheet

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WHILE YOU MAY CONSIDER a balance sheet to be an essential financial statement for a company, assessing your own personal assets, equity and wealth in a well-laid-out financial report is equally important. Typically updated at least once a year, these financial documents outline how much someone owns, what they owe and how much they are worth.

“It keeps track of your financial picture,” says Harvey I. Bezozi, a CPA and founder of Your Financial Wizard, a tax consulting firm in Boca Raton, Florida. For businesses, they offer a way to measure the value of an organization while personal balance sheets can be valuable tools to track progress toward goals such as getting out of debt, retiring early or funding a college education.

“It’s not as complicated as it sounds,” says Krista Morgan, CEO of P2Binvestor Inc., a company offering business loans. Here are the basic steps to building a balance sheet:

List all assets and their current, fair market value.
List all debts and liabilities.
Calculate total assets and total liabilities.
Subtract the value of liabilities from the value of assets.
The result is the equity/net worth of a business or person.
The biggest mistakes people make when creating a balance sheet is leaving items off and using incorrect market values for assets, says Rich Ramassini, the director of strategy and sales performance for the financial firm PNC Investments. Another misstep is recording the value of assets and investments on different days. “It’s a snapshot in time,” Ramassini says, and the sheet loses its integrity if the values don’t represent the same period.

To learn more about how businesses create balance sheets, why you should build your own and what to do with it once it’s created, here’s a primer.

What Is a Balance Sheet?

A balance sheet is a helpful tool for businesses both internally and externally. It is often used in conjunction with other documents, such as an income statement, which demonstrates profit or loss, and a cash flow statement that lists how a business spends and received money. Together, these documents provide a clear picture of an organization’s overall financial health.

“Your balance sheet gives you a picture of (whether) you are actually creating value in your business,” Morgan says. In practical terms, it can be used to attract investors, justify a loan or set a price should a company be sold. The bottom line of a business balance sheet lists shareholders’ equity, with a larger number being a common indicator of a healthy company. The documents can be used for tax-planning purposes and should list deferred tax liabilities.

While every balance sheet will contain assets, liabilities and equity, the document will vary depending on a company’s needs and size. “It could be one page or it could be 50 pages if it has footnotes attached,” Bezozi says. Large corporations may use a team of accountants to prepare bound balance sheets, while money-savvy small business owners may be able to create a simple document without outside assistance.

Line items on a balance sheet will vary by business. For instance, a retail clothing store may have assets that include inventory and a building, while a service-based business like a cleaning company may have equipment or vehicles instead. Meanwhile, both companies may have liabilities that include taxes, business loans and payroll expenses.

How to Create a Personal Balance Sheet

While balance sheets are the norm in the business world, they are not as frequently used by individuals. That means you could be overlooking important financial information and missing out on the opportunity to learn more about areas where you can improve to achieve your long-term money goals.

To create a personal financial statement, you could take a DIY approach. “There is no shortage of templates online,” Ramassini says. But he notes this method increases the chances of mistakes. For instance, someone writing their own balance sheet may not realize loans on a life insurance policy should be listed as a liability or understand how best to value real estate assets.

Working with a professional can help avoid mistakes and also open the door to greater financial literacy. Rather than turning the creation of a balance sheet over to an accountant entirely, Morgan suggests taking an active role in reviewing and understanding the numbers included. “It’s sitting down with someone and asking questions,” she says.

How to Analyze a Balance Sheet

Once the balance sheet is created, it can quickly become apparent where a person or business has financial deficiencies and areas for improvement. In a worst-case scenario, a balance sheet may reveal negative net worth, in which case it’s imperative to find ways to either increase income or decrease debt.

However, the bottom line isn’t the only important part of this financial document. At a glance, it provides an overview of how much is saved for specific goals and where debt is concentrated. For instance, on a personal balance sheet, you might identify significant savings for a child’s college education, while neglecting to build a nest egg for retirement. You may also discover multiple accounts serving the same purpose, such as several buckets of emergency savings, and decide whether it is best to consolidate those accounts.

“You use that (intel) to inform your financial decisions,” Ramassini says. The ultimate goal of a balance sheet is to see if spending and savings align with personal or business goals. If not, you may need to adjust your budget or cash flow plan. Then, when the balance sheet is updated quarterly or annually, you can track if those changes are moving your financial situation in the right direction or if additional action must be taken. For example, a couple upping retirement savings contributions will be able to quickly see if that change has increased their account balances as expected. If not, that could indicate a need to adjust investments or further increase contributions.

For investors, a company’s balance sheet can also be used to determine whether shares are worth buying. Factors such as a debt-to-equity ratio can determine whether a company is overleveraged and saddled with too much debt. While the average debt-to-equity ratio can vary by industry, a number below 2.0 is often considered preferable. Other red flags may include maturing long-term debt that could be costly, disposal of fixed assets and a high number of miscellaneous expenses. While a balance sheet provides a way to track business trends, investors should remember the document offers a record of historical data and not necessarily an indication of a company’s future.

Whether you own a business or manage a household, a balance sheet is a valuable tool. It’s a picture of where your money is today and offers a starting point to create the business plan or budget needed to achieve your future financial goals.

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