What is a balance sheet? Does an unincorporated business have to prepare a balance sheet? What are the benefits of preparing a balance sheet?
This is a freeview 'At a glance' guide to unincorporated businesses and preparing a balance sheet.
At a glance
What is a balance sheet?
A balance sheet shows a business's assets, liabilities and equity at the date it is prepared.
Balance sheets can be a useful report for all but the smallest of businesses as they provide a 'snapshot' of the assets, liabilities and net book value of the business at its year-end.
As part of the double-entry bookkeeping system, the balance sheet also provides vital evidence that the accounts balance, or that they have been made to balance.
A balance sheet also:
- Gives the owner a way of comparing their results and net worth year-on-year.
- Can be used to analyse results and indicate potential problems such as a build-up of stock, excessive/slow-paying debtors or cash-flow problems.
- Shows how capital is employed and how much cash the owner withdraws from the business.
Lenders often like to see a balance sheet as it provides detail of assets (possibly for security) and existing debt obligations.
Do I have to prepare a balance sheet?
There is no legal requirement for an unincorporated business such as a sole trader or partnership to prepare a balance sheet for tax or any other reason.
If you are using a computerised bookkeeping system it may well automatically provide a balance sheet in its reporting system.
If you are still manually bookkeeping or keeping a very simple online cash book, it may not seem cost-effective to prepare one if the business is very small.
A key point is that some business owners never understand the point of a balance sheet: many non-accountants struggle to read any meaning from one unless they are shown what the figures mean and how they tie in to the overall accounts.
To decide whether to prepare a balance sheet consider:
- The size of the business.
- The cost of the extra work in preparing a balance sheet.
- The benefits of having a balance sheet year on year.
- Tax risk (see the Tax Risk Review) and the overall risk of not having a balance sheet.
If the business has fixed assets, debtors and creditors, accruals and prepayments, a separate bank account or a cash control account, it is generally easier to create a balance sheet to reconcile and keep track of opening and closing balances.
When a double-entry bookkeeping system is used, and the balance sheet forms part of it, reconciling and proving each asset, liability, capital introduced and drawing balance provides comfort that profit is correct. This stems from the accounting equation: assets = liabilities + equity.