The balance sheet is a snapshot of a company’s resources and liabilities at a given point in time. It is essential for assessing a company’s financial health, solvency and ability to generate future cash flows. Whether you decide to do it yourself or delegate the task to a chartered accountant, it’s essential to know how to prepare a balance sheet! We’ll take you through it step by step.
Definition of the balance sheet
The balance sheet is an essential financial document that summarises a company’s financial position at a given point in time, usually at the end of the financial year. It shows the company’s assets, liabilities and equity, structured to show clearly what the company owns and what it owes.
Here are the main components of an accounting balance sheet:
- Assets: assets represent the resources controlled by the business that are expected to bring future economic benefits. Assets are generally classified into current assets (such as cash in hand, stocks and trade receivables, all of which are expected to be converted into cash or used within a year) and non-current assets (such as buildings, machinery and patents, which are used over a longer period).
- Liabilities: liabilities are financial obligations or debts that the company must repay to third parties. As with assets, liabilities can be classified as current liabilities (trade payables, wages payable, short-term loans) and non-current liabilities (long-term debt, mortgages, long-term bonds).
- Equity: also known as shareholders’ equity or net worth, equity represents the part of the company that belongs to the shareholders or owners after deducting all debts. It includes share capital, retained earnings and reserves.
What is the purpose of the balance sheet in accounting?
The main purpose of the balance sheet is to determine a company’s financial position at the end of the accounting period (usually the year), since it shows what it owns and what it owes at that point in time. The balance sheet provides a clear view of all assets and liabilities.
Creating a balance sheet for a company allows you to:
- Assess risks and opportunities: by comparing current assets with current liabilities, it is possible to judge whether the company has the necessary funds to pay its immediate debts (such as wages and rent) or whether it needs additional financing.
- Facilitate access to finance: balance sheets are often used by lenders and investors to assess a company’s ability to repay its debts and manage its assets efficiently.
- Demonstrate long-term viability: by analysing balance sheets and financial ratios, it is possible to assess a company’s profitability, productivity and liquidity, and also to compare its performance with that of its competitors.
- Analyse its financing capacity: this analysis reiterates the importance of evaluating short-term assets and liabilities to determine the company’s ability to cover its immediate financial commitments.
Preparing your balance sheet: 4 tasks to carry out beforehand
1. Update entries in the general journal
The general journal is the primary register in which all the company’s day-to-day transactions are recorded chronologically. Depending on their accounting practices, some companies may also use specialised journals, such as a sales journal, a cash receipts journal or a purchases journal.
So, before compiling the main financial statements (including the balance sheet), it is essential to update the accounts at the end of each accounting period to include transactions not yet recorded. Take the example of a delivery of goods valued at €5,000 made on the last day of the month: if payment for these goods is not received until after the period-end, the corresponding entry must be adjusted in the general journal.
2. Transfer transactions to the general ledger
Once the transactions have been recorded and updated in the general ledger, they are transferred to the appropriate accounts, such as sales, purchases, accounts receivable, inventory and cash. This process is called posting.
While the general journal records day-to-day transactions, the ledgers organise them by account. At the end of the accounting period, the various accounts are compiled in the general ledger, which serves as the basis for drawing up the balance sheet and financial statements.
3. Establish the final trial balance
The next step is to prepare a final trial balance. This document summarises the balances of all the ledger accounts, making it easier to check totals and identify any accounting anomalies.
The trial balance should show that the total sum of debits equals the total sum of credits. If the totals do not match, this may indicate errors such as omitted transactions or data entry errors. A thorough review is then necessary.
4. Preparing the profit and loss account
Before drawing up the balance sheet, it is essential to prepare a profit and loss account to calculate net income, which is your company’s net profit or loss. This amount appears on the final line of the profit and loss account. After calculation, the net income is incorporated into the retained earnings accounts, which form part of the equity section of the balance sheet.
To draw up the profit and loss account, start by extracting income and expenditure from the trial balance and classifying them to obtain a clear view of financial performance.
How to do your balance sheet in 6 steps?
1. Set a closing date for the balance sheet
An accounting balance sheet therefore reflects the financial situation at a specific point in time, rather than over a period. Usually, the balance sheet is drawn up at the end of the financial year, often on the last day of March or December, but it can also be prepared quarterly or half-yearly. The balance sheet heading should indicate a specific date, such as ‘at 31 December 2024’.
2. Collect accounts for the balance sheet
Examine the general ledger and trial balance to identify the permanent accounts (e.g. cash, fixed assets) whose balances are carried forward to the next period. Only these accounts are included in the balance sheet. Make a note of their balances for future use.
3. Calculate total assets
Identify and list the asset accounts (cash, stocks, etc.) from your trial balance. Classify them into current assets (convertible into cash within the year) and non-current assets (used over the long term). Then add up the values for each category to obtain the total assets.
4. Calculate total liabilities
Determine which accounts represent your obligations (such as accounts payable and borrowings) and record them as your liabilities. These can be divided into current liabilities (due within a year) and non-current liabilities (long-term). Add these values together to obtain your total liabilities.
5. Classifying assets and liabilities
Organise assets in order of liquidity and liabilities by maturity in a relevant order. Assets that are easily convertible into cash are listed first, followed by more permanent assets. Similarly, short-term bonds are listed before long-term ones.
6. Calculating shareholders’ equity
Equity reflects the company’s net worth and includes the owners’ investments and accumulated gains or losses. It therefore includes :
- Ordinary shares and preference shares: these terms refer to the different types of shares issued by a company. Holders of ordinary shares generally have voting rights in company decisions, but in the event of liquidation, they only receive a refund after full payment has been made to the holders of preference shares.
- Treasury shares: these are shares that the company has bought back on the market. This practice is often used to prevent or discourage hostile takeover attempts, by reducing the number of shares available to the public.
- Retained earnings: these correspond to profits that have not been distributed to shareholders in the form of dividends but are reinvested in the company. The calculation of retained earnings takes into account the company’s net income, plus accumulated retained earnings from previous periods, less any dividends paid during the period.
Add these values together to obtain total equity. Then combine this total with the total for liabilities to obtain the total for liabilities and shareholders’ equity.
How do you produce a functional and financial balance sheet based on this accounting document?
Creating a functional balance sheet
The functional balance sheet rearranges the elements of the accounting balance sheet according to their role in the company’s activities, such as investment, financing, operations and non-operating transactions. In this balance sheet, assets are referred to as ‘uses’, while liabilities are called ‘resources’. This reorganisation helps us to understand how resources are used in the business. It is crucial to carry out this analysis meticulously to avoid errors in data classification.
Creating a balance sheet
The financial balance sheet, although it includes the same items as the accounting balance sheet, reorganises assets according to their liquidity and liabilities according to their maturity. This type of balance sheet is used to assess the company’s ability to cover its short- and long-term financial obligations, providing a precise perspective of its solvency. This balance sheet is particularly useful for quick analyses and can be easily prepared using data from the accounting balance sheet.
Thanks to LMB’s administrator interface, you can easily export your accounts by downloading your sales, purchases, cash, bank and other transaction journals. Extractions can be made in the format compatible with your accounting software (Sage, Cegid, Quadra, Ciel, Cador, IsaCompta, EBP, etc.). No more manual adaptation of formats: our software takes care of it for you! What’s more, the direct debit module lets you generate your export files automatically.
