The Benefits of Using a Balance Sheet
Balance sheets are used internally to guide management decisions. Externally, they can be used to report your business’s financial status to lenders, investors, and other stakeholders.
Also known as statements of financial position, balance sheets reveal what you own (your assets). They also show what you owe (your liabilities) at a specific point in time. The difference — shareholders equity — is your company’s net worth.
Diligently tracking your company’s finances can help you identify potential issues before they turn into major problems. In fact, 29 percent of small businesses fail because they run out of cash. This is an issue that may be avoided through proper reporting.
Ultimately, a balance sheet provides the information you need to sustain and grow your business over time. Creating one doesn’t need to be complicated, and its benefits can be far-reaching. Let’s explore three notable advantages of balance sheets in this post.
What Are the Benefits of Balance Sheets?
1. It Determines Risk and Return
A balance sheet succinctly lists your assets and liabilities in one place. Current and long-term assets reflect your ability to generate cash and sustain operations. In comparison, short- and long-term debts prioritize your business’s financial obligations. Ideally, you have more assets on your balance sheet than liabilities, indicating positive net worth.
Comparing your current assets to current liabilities determines whether your business can cover its short-term obligations. If your current liabilities exceed your cash balance, your business may require additional working capital from outside sources. However, a balance sheet can also show you when your debt levels are unsustainable. If you have too much debt on your balance sheet, you may default on debt payments or declare bankruptcy.
2. It Can Be Used to Secure Loans and Other Capital
Your balance sheet allows people outside of your company to quickly understand its financial condition. Most lenders require a balance sheet to determine a business’s financial health and creditworthiness. Additionally, potential investors may use it to understand where their funding will go and when they can expect to be repaid.
When updated over time, your balance sheet effectively shows your ability to collect payments and repay debts. Plus, it shows lenders that you have a track record of managing assets and liabilities responsibly. If you apply for a loan, it will also show lenders that you’ll likely repay your debts in a timely manner.
3. It Provides Helpful Ratios
Ratios are often used in financial statement analysis to indicate a company’s operational efficiency, liquidity, profitability, and solvency. These financial ratios are particularly helpful when assessing the long-term sustainability of a business. They can be determined by a company’s balance sheet accounts.
For example, your balance sheet is a snapshot that reveals your company’s overall capital structure. It can also tell you how long it takes to sell inventory and the length of your accounts receivable process. This information can help you identify trends and see how your company’s finances and operations compare to competitors.
Conclusion: Make Financial Reporting a Priority!
Preparing and understanding your company’s financial statements is an important part of being a small business owner. The balance sheet is particularly helpful in that it keeps both you and your stakeholders informed of your financial standing. Keeping this information updated can help you make better management decisions. In addition, it may improve your business’s operational efficiency, borrowing habits, and overall financial health.
Does your business utilize a balance sheet? Tell us what your top tips are in the comment section below!
Editor’s Note: This post was updated for accuracy and comprehensiveness in March 2019.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.