Balancing your small business’s balance sheet doesn’t have to be difficult. By making sure your assets equal your liabilities plus your shareholders’ (also called, owners’) equity you will avoid having difficulty paying your operating expenses, which was a top concern of 40% of small businesses in 2017. To start your calculation, you’ll need to use a basic formula.
The Basic Formula
Don’t let the idea of a math formula scare you off. Your balance sheet formula isn’t going to be difficult to use. The formula is:
Assets = Liabilities + Owners’ Equity
To break this formula down, you’ll want to focus on each part individually. These are:
- Assets. Your assets in the equation will include everything your small business owns. This can include cash, inventory, and accounts receivable.
- Liabilities. These include what your small business owes to others, such as bank loans, credit card payments, and accounts payable.
- Shareholders’ (Owners’) equity. This is the difference between your assets and your liabilities. This equals the investment or capital that owners have in your small business.
What Does the Balance Sheet Equation Mean?
Every math equation or formula serves a purpose. This you probably already know. So what is the real meaning behind the balance sheet equation? It shows what your small business owns, owes, and what shareholders have invested in your small business. This math serves as the foundation of your balance sheet.
Every balance sheet should balance. You’ll know your sheet is balanced when your equation shows your total assets as being equal to your total liabilities plus shareholders’ equity. If these are not equal, you will want to go through all your numbers again.
Balance Sheet Equation Examples
Before you jump into using the balance sheet formula, you may want to give it a few practice tries. To start, you can work through some balance sheet examples and really put the equation to work.
Example 1. For a starting example, say you start out with no assets, liabilities, or shareholders’ equity. You then acquire a $20,000 loan from the bank to pay for startup costs. Your equation will go from:
Assets (0) = Liabilities (0) + Owners’ Equity (0) to
Assets ($20,000) = Liabilities ($20,000) + Owners’ Equity (0)
Example 2. In the next example, consider this theoretical scenario:
A small business purchases new equipment for $600 on credit. The balance sheet equation would reflect this example scenario by:
Assets ($2,000 [$1,400 + $600]) = Liabilities ($600) + Owners’ Equity ($1,400.)
Your assets account was increased by $600 dollars to equal $2,000. Your liability account for purchases made on credit was also increased by $600. Throughout this whole transaction, your accounting equation should stay in balance.
Example 3. Now that you understand how the equation works with simple numerical examples, consider a real world example. The Hartford’s balance sheet for December 31, 2017 balanced using these numbers:
The assets section of this equation includes both current and long-term assets. Here’s a breakdown of the numbers included in total assets:
- Cash and cash equivalents accounted for $180,000 of the total $225,260,000.
- Short-term investments accounted for $2,270,000 of the total $225,260,000.
- Net receivables accounted for $7,971,000 of the total $225,260,000. Net receivables are the total money owed to a business like The Hartford.
- Long-term investments accounted for $207,812,000 of the total $225,260,000.
- Fixed assets accounted for $1,034,000 of the total $225,260,000.
- Goodwill accounted for $1,290,000 of the total $225,260,000.
- Intangible assets accounted for $659,000 of the total $225,260,000.
- Other assets accounted for $2,230,000 of the total $225,260,000.
- Deferred asset charges accounted for $1,814,000 of the total $225,260,000.
Within the total liabilities section:
- Long-term debt accounted for $4,998,000 of the total $211,766,000.
- Other liabilities accounted for $206,768,000 of the total $211,766,000.
Why the Balance Equation Is Important
Your balance sheet is not only a fundamental part of your small business’s operation. It also helps you, as well as others, understand your own financial operation in a deeper and more organized way.
In addition to this, it works hand in hand with your other financial statements to help you and others gain a well-rounded look at your small business’s finances. This includes your income statement and cash flow statement. It also helps you with:
- Communicating your financial standing. Customers, investors, and other interested parties will be able to get a feel for your business by looking at your balance sheet.
- Recording your debits and credits accurately. Any errors in recorded data will likely arise as you fill out your balance sheet. This can help ensure accuracy in both your record-keeping and financial decision-making.
You’ve likely taken a math class before. This means you know that errors can occur easily and frequently when dealing with numbers. Your balance sheet math will be no exception. When doing your calculations, you’re bound to run into an issue here and there.
Potential issues can arise depending on how you tallied your information and what information you chose to include. For example, sometimes when you’re creating your balance sheet, your total assets may not match your total liabilities plus your shareholders’ equity. When this happens, it may be due to:
- Rounding errors. Balance sheets typically use whole numbers. So you will want to make sure you are rounding correctly. For example, say you have the number 1,001.11. This would round to 1,001 on your balance sheet.
- Unbalanced numbers. Your balance sheet may come out with unbalanced numbers. When this occurs, you’ll want to review all of your numbers and the placement of each. It can be easy to mix up numbers.
- Damaged data. Accounting files that are damaged can cause unexpected inaccuracies in your numbers.
- Misplaced data. If you or your employees misplace an accounting file, your numbers can be unbalanced as a result. This can then lead to inaccuracies.
- Foreign currency transactions. If you export any of your products overseas, you will need to pay attention to exchange rates. These rates can change frequently, which may in turn lead to inaccuracies in your balance sheet. Be sure to keep up with these rates.
- Errors in your equity calculations. Always check your total for owners’ equity. It’s important to remember that as your assets increase, your equity also will increase.
- Unbalanced transactions. Similar to unbalanced numbers on your balance sheet, you can enter transactions into your system wrong. You may accidentally input a transaction on the asset side instead of the liability side. Cross-checking your records can help you avoid these errors.
Other errors that can affect balance sheets and your equation include:
- Data that is classified incorrectly. This can occur if you accidentally mix up your data and record it in the wrong area of your balance sheet.
- Data entry errors. These can be oversights or even typos for certain numbers.
- Omitted data. This can occur when you forget to add certain data that you need to include on you balance sheet.
As you set up, create, and check to make sure your balance sheet balances, pay attention to what you see. Take a close look at each section of the balance sheet: your assets, your liabilities, and your owners’ equity.
Each section of the balance sheet can provide you with important financial information you can use to improve your small business. Be sure to consider how each section intersects, interacts, and connects, as well. Considering the whole picture can give you better insights to help you make the correct future financial decisions.