1.6 – What’s a Balance Sheet and Why Do I Need One?
A balance sheet offers a way to look inside your business and outline what it is really worth. A balance sheet is different from a measure of profit and loss. It’s a list of assets and liabilities. Any good balance sheet includes some basics:
I) What the business owns (real estate, vehicles, office equipment, etc.)
II) Revenue you expect to take in (accounts receivable)
III) Expenses you expect to pay out (accounts payable)
Getting into the details can be daunting for many people, who when they start a business might be doing it as a hobby that makes money. At that point, real accounting isn’t as necessary, and many people don’t even bother to keep records. That can be a mistake when your business starts generating real income, and even if it doesn’t.
If you want to claim tax deductions, for instance, it’s important to note how fast and by how much your assets are depreciating (losing value with age). Balance sheets also include the costs of labor, which is also important for tax calculations. Keeping records of all these is essential.
Also, if you ever want to sell the business, you have to be able to say what the real value of the asset is — and that often has little to do with its potential, however good it is.
The cost of hiring an accountant for a one-time job is a few hundred dollars; the cost of paying fines to the Internal Revenue Service, or the potential lost money in tax breaks is often much more.
Brigham also notes a balance sheet is a good reality check. “Everybody thinks their business is worth more than it really is,” he says. If you are planning to sell your business or incorporate it, the total worth is vital information. If you’re applying for a small business loan , it helps to have something to show the bank you’ve done your homework.
A common pitfall of many entrepreneurs is to try and do everything themselves. Delegating balance sheet creation to a professional (or a friend who is an accountant) avoids that problem. In addition, a balance sheet will tell you if your business is really profitable to your household or not. He notes that oftentimes business owners just guess at profitability, without really calculating the carrying costs of many assets.
Real estate, for example, has to appreciate faster than both inflation and the interest cost of the loan in order to turn a profit. If your business owns a piece of property and that price appreciation doesn’t happen, that asset is actually worth less.
A vehicle loses value every year, and that can count against the total worth of an enterprise because maintenance costs go up, not down, over time. But depreciation isn’t all bad. It can add up to big tax deductions in some cases — but unless you know how much, you can’t claim those breaks.