March 16, 2022 by Adam Hoeksema
Every startup owner needs to be well aware of how their business is doing. A great way to get this perspective is by preparing and understanding crucial financial statements. Among these documents is the startup balance sheet, a document that gives a snapshot of the firm's current financial position. Although it can be challenging to prepare, it is helpful to startups due to its conciseness and accuracy. This article will discuss what a startup balance sheet is and show you how to prepare one.
What is a Startup Balance Sheet?
A startup balance sheet or projected balance sheet is a financial statement highlighting a business startup's assets, liabilities, and owners' equity. In other words, a balance sheet shows what a business owns, the amount that it owes, and the amount that the business owner may claim. A balance sheet operates on the principle that the sum of liabilities and owners' equity equals its assets. If a business is a true startup with no historical data or assets to the business yet, you can create what is called a projected balance sheet as well.
Most other startup financial statements are prepared for a given fiscal period, such as a year or a quarter. A balance sheet precisely represents the startup's financial position at a point in time. Its contents depend on when it's prepared and reflect every financial decision made up to that point.
Balance sheets are important financial documents, not only because they give a bird's-eye view of the entire finances. They also give investors a good idea of how the business is doing and the assets into which cash is poured. This makes the balance sheet crucial for securing investments and loans from investment firms, private investors, and banks.
Why You Need a Balance Sheet
Balance sheets are crucial financial statements for every business, including startups. There are several reasons why your startup will need a balance sheet. Some of them are:
- It gives a snapshot of the business
As Inc. Magazine showed, most owners of failed businesses do not realize that the business is failing until it is too late. This occurs because they fail to regularly check the business's accounts and balance sheets. As a result, they do not make important changes quickly enough. Checking your balance sheet regularly shows you how inflow is being managed to facilitate growth.
- It helps your startup secure loans and investments
Before a bank or any other financial institution offers loans to a business, they must ensure that their financial documents and projections are up-to-date and of a required standard. Additionally, investors want to be confident in the business owners' ability to give them a profitable return. A balance sheet is one of the crucial documents that these institutions will examine to ensure that business owners are competent.
- It reveals trends in the business
Since balance sheets compare the value of specific assets and liabilities over time, they can show recurring or progressing trends in the business. For example, if you're constantly overstocked or understocked, it'd appear in the size of your inventory. If you're taking more loans than you need, it'd also appear. This allows you to make changes and improve productivity.
- It contributes to decision making
Business owners need to make sound decisions based on the company's financial position. A balance sheet is a crucial document that reveals this position. With a good knowledge of the business's financial position, leaders are better equipped to make positive decisions for the company.
What to Include in a Balance Sheet
The contents of a balance sheet vary widely but belong to one of three classes. This section describes the contents to include in your startup balance sheet:
Assets are items that a business owns and may use to generate profit through its business activities. The sources of these assets include liabilities, or borrowings, and equity, which is the amount that the business owner and investors put into the business. Assets can be divided into two categories – current assets and non-current (fixed) assets.
Current assets are items that the business can convert to cash in a short period, usually a year. Current assets include cash, short-term investments, accounts receivable, and inventories. Typically, they appear at the top of the list.
Fixed assets or non-current assets cannot be converted to cash within a single year. They are referred to as illiquid assets and have a longer lifespan when compared to current assets. Fixed assets include tangible assets such as land, buildings, stocks, machinery, bonds, and long-term investments.
Fixed assets may also be intangible, such as patents, goodwill, copyrights, trademarks. A brand name is also another intangible asset that may be of great value. The value of fixed assets is subject to appreciation and depreciation. Typically, fixed assets appear at the bottom of the list of assets.
Liabilities are items that the business owes to entities outside of the business. It is one of the sources of capital to run the business. It is, therefore, an essential component of the balance sheet. Liabilities may also be described as financial obligations a company has to others. Often, they appear with the tag “payable.” Liabilities may also be classified into two groups: long-term and short-term liabilities.
Short-term liabilities, or current liabilities, are financial obligations that the business must pay in less than a year. These include outstanding bills, unpaid dues, and taxes payable. Unpaid salaries and wages may also be a form of short-term liability. Short-term liabilities appear at the top of the list in the balance sheet.
Long-term liabilities are financial obligations that the business is not due to pay until a period much greater than a year. These include bank debt, bondholder debt, and other loans that are not due until over a year. They generally appear at the bottom of the balance sheet.
Equity is the value of ownership in a business. It also represents the amount that business owners have invested into their business. Equity comprises both paid-in funds and retained earnings. There are two kinds of equity: shareholders' equity and owner's equity.
Owner's equity refers to the value of the investment that a sole proprietor puts into the business. If the company has some investors, the investors' stake in the company is known as shareholders' equity. Equity can be calculated as the total value of assets minus the company's liabilities. Its value gives the net worth of the business. According to Investopedia, it refers to the amount paid to all investors if the business were to be liquidated at a given point in time.
The balance sheet equation gives a critical relationship between the three main components of a balance sheet. It reads thus: Assets = Liabilities + Equity
Types of Balance Sheets
There are several types of balance sheet formats available. Although each format highlights different aspects of the balance sheet, the basic principle of assets, liabilities, and owner equity is applied. Here are a few types of balance sheets you can consider:
- Classified Balance Sheet
Like a typical balance sheet, a classified balance sheet contains all the assets and liabilities of the business. But the critical difference here is that the information on assets, liabilities, and equity are placed into categories. The classified balance sheet is one of the most used. It makes it easier to compare balance sheets over different periods, tracking the growth of the business.
- Unclassified Balance Sheet
This type of balance sheet is more straightforward than the classified. It simply lists all the items rather than categorizing them. This format is helpful for businesses with only a few items on their list. Typically, you'd list the assets and liabilities from top to bottom in decreasing order of liquidity.
Liquidity measures how easily the business can turn assets into cash. This means that cash assets and liabilities should appear at the top of the list, while buildings and other fixed assets should appear at the bottom. Unclassified balance sheets are more common in small businesses.
- Common Size Balance Sheet
A common size balance sheet contains all the information on assets, liabilities, and equity-like a classified balance sheet. However, it also includes a column that lists the same information but as a percentage of the total. This means that each asset is listed as a percentage of the total value of assets. Also, each liability is listed as a percentage of the total liabilities and equity.
A common-size balance sheet helps compare relative changes in the company's pool of assets, liabilities, and equity. For example, suppose you'd like to observe how cash varied with time or how inventory values have increased over the years. In that case, you can use a common-size balance sheet.
- Comparative Balance Sheet
The purpose of a comparative balance sheet is to compare the business’s financial position at different points. A comparative balance sheet lists the assets, liabilities, and equity of a business at different times, arranging them side by side. This arrangement makes it easy to observe changes over time.
- Vertical Balance Sheet
This is another simple and commonly used format. A vertical balance sheet lists all the assets, liabilities, and equity in a single column. In a vertical balance sheet, you list assets first, followed by liabilities, and finally, equity. Like an unclassified balance sheet, it's customary to arrange items in decreasing order of liquidity, with cash and other liquid items on the top.
How to Create a Balance Sheet For Your Startup
According to the balance sheet equation, a business's assets must equal the sum of its liabilities and equity, which are the sources of its possessions. Arranging the information for a balance sheet might seem difficult, especially for a startup. This guide will help you to overcome these difficulties to create a balance sheet:
- Seek the guidance of an accountant
Preparing your first balance sheet, known as an opening day balance sheet, can seem quite scary. If you have not prepared a balance sheet before, you may need the advice of an expert to get started. This helps you avoid mistakes such as unreported assets or undocumented liabilities, which may present an inaccurate picture of the business.
Additionally, an expert accountant is in a great position to give you financial advice which can help grow the company. Nowadays, most startups even outsource their financials to accountants. You may not be able to afford this as a new startup. Still, with a few hundred dollars, you can gain enough from their expertise to boost the financial security of your business.
- Choose a date to prepare the balance sheet
Most businesses prefer to prepare a balance sheet at the end of a fiscal year or, in other cases, at the end of each quarter. For you, this date may be the end of a financial period, at the beginning of the month, or any other date relevant to your business. Most businesses may still be preparing the balance sheet a few weeks after the date has passed.
Choosing the date to prepare the balance sheet allows you to collect documents, receipts, and files relevant to that point in time. This date should appear at the top of the balance sheet, typically part of the title.
- Gather the necessary data
After choosing the date for preparing the balance sheet, you'll need to collect all the necessary data. Collect important receipts, sales invoices, and request relevant bank statements. Determine how many loans you've taken as a business and how much is due to you. Don't forget to estimate the value of intangible assets, such as patents and trademarks. Having the necessary data handy makes it easier to create a balance sheet.
- Follow a standard format
A balance sheet follows a standard format in which assets, liabilities, and equity occupy designated columns. Ensure that your balance sheet follows a standard format so that it can be easily interpreted by investors and other firms interested in your business. If you're not sure how to present your balance sheet, Projection Hub has several pre-saved templates that can save you work hours. Projection Hub has several custom templates for almost any kind of business.
Here is a sample balance sheet from a fictional startup as a guide:
- Prepare the assets section
Under the Assets section, create a subheading for current assets first. Under this subheading, list all your current assets such as cash, inventory, accounts payable, et cetera. Be sure to list the items from most liquid to least liquid. Add up the subtotal of current assets, and include it in your balance sheet as “Total Current Assets.”
Then, create a section for fixed assets. Here, you can include items like plants, equipment, and long-term investments. Don't forget to add the intangible assets as well. Find the subtotal of the fixed assets. Finally, include the total of all assets.
- Add the liabilities section
Under the Liabilities section, create a subheading for current liabilities. Under this subheading, list all repayments due within a year, such as short-term debts, salaries payable, and accounts payable within a year. Add up the subtotal and list it in your balance sheet.
Also, create a subheading for long-term liabilities. In this section, list all repayments due in more than a year, such as bank loans and mortgages. Include the subtotal in your balance sheet. Finally, add up the total value of the liabilities, and include this in the balance sheet.
- Include an equity section
Under this section, include the amount invested in the business by shareholders and the business owner. Be sure to add any retained earnings which went into the business. Add these up as the total equity.
- Ensure the accounting equation is balanced
Finally, add up the total assets and the total liabilities and equity. Compare the two values – they should tally. If they do, your balance sheet is complete. If they do not tally, you may need to visit your data to check for omitted or miscategorized figures. Ensure that these are taken care of, and work on the balance sheet again.
And if you’d like to use a tool to develop a 5 year projected balance sheet, you can use our financial projection templates here at ProjectionHub which will automatically generate your balance sheet with your information. We also have a completely free standalone Balance Sheet template you can download here!
A balance sheet is an essential financial statement that captures the strength of a business's financial position. Although preparing a balance sheet might seem difficult for a new startup, preparing one is well worth it. With a well-prepared balance sheet, you become informed enough to make excellent decisions that would move your company forward.
Not ready to make a full blown projected balance sheet yet? Check out our free balance sheet template: