Accounting Concepts and Practices

How to Prepare a Balance Sheet Step by Step for Your Business

Learn how to create an accurate balance sheet by organizing assets, liabilities, and equity to better understand your business’s financial position.

A balance sheet is a fundamental financial statement for any business, offering a snapshot of what a company owns and owes at a specific point in time. Whether seeking financing, evaluating company health, or preparing for tax season, an accurate balance sheet informs decision-making.

Creating a balance sheet can seem daunting initially, but breaking it down into steps simplifies the process. This guide walks through preparing a balance sheet step-by-step, enabling you to build one that reflects your business’s financial position.

Choosing a Format

The first consideration is how to structure the information. Standard accounting practices offer two main styles: the report format and the account format. Both arrange assets, liabilities, and equity but differ in layout, often chosen based on audience, business complexity, or software capabilities.

The report format presents the balance sheet vertically, listing assets first, followed by liabilities, and then equity in a single column. This format is common for internal review or simpler businesses, as some find it easier to read with totals listed sequentially.

The account format uses a horizontal layout, resembling a ‘T’. Assets are detailed on the left, while liabilities and equity are on the right. Totals at the bottom visually demonstrate the accounting equation: Assets = Liabilities + Equity. This format clearly separates what the company owns from how those assets are financed.

Accounting standards like U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) offer flexibility in choosing between the report and account formats. Both frameworks focus on ensuring the presented information is clear, understandable, and includes required classifications, such as distinguishing between current and non-current items, rather than mandating a specific layout. Guidance like IAS 1 outlines presentation requirements.1IFRS Foundation. IAS 1 Presentation of Financial Statements Upcoming standards, such as IFRS 18, may introduce more specific structural requirements for financial statements but are expected to maintain flexibility for the balance sheet’s overall format. The chosen format should effectively communicate the company’s financial position.

Grouping Current and Long-Term Assets

After selecting a format, the next step involves identifying and organizing the company’s assets – resources owned that hold value and provide future economic benefits. Classifying assets correctly is fundamental. The primary division is between current assets and non-current (or long-term) assets, based on when the asset is expected to be converted into cash, sold, or consumed.

This classification generally hinges on a one-year timeframe or the business’s normal operating cycle, whichever is longer. The operating cycle is the average time to acquire materials, convert them into products, sell them, and collect cash. For many businesses, this cycle is under a year, making the one-year rule applicable.

Current assets include cash and resources expected to be realized, sold, or consumed within one year or the operating cycle. They are typically listed by liquidity:

  • Cash and Cash Equivalents: Physical currency, bank account funds, and highly liquid short-term investments (e.g., Treasury bills maturing in three months or less).
  • Marketable Securities: Readily convertible short-term investments like publicly traded stocks or bonds.
  • Accounts Receivable: Money owed by customers for delivered goods or services, shown net of an allowance for doubtful accounts.
  • Inventory: Raw materials, work-in-progress, and finished goods held for sale.
  • Prepaid Expenses: Advance payments for future goods or services (e.g., prepaid rent or insurance).

Assets not meeting the current criteria are non-current or long-term. These resources are expected to be held and used for more than one year or operating cycle and are fundamental to long-term operations. They include:

  • Property, Plant, and Equipment (PP&E): Tangible assets like land, buildings, and machinery, recorded at historical cost less accumulated depreciation (except land). Depreciation allocates the cost over the asset’s useful life, as guided by standards like ASC 360.2PwC Viewpoint. Property, Plant, and Equipment Guide: Depreciation (ASC 360)
  • Intangible Assets: Assets lacking physical substance but providing value, such as patents, copyrights, trademarks, and goodwill. Finite-lived intangibles are amortized; indefinite-lived ones (like goodwill) are tested for impairment annually per guidelines like ASC 350.3PwC Viewpoint. Goodwill and Other Intangibles Guide: Accounting for Intangibles After Acquisition (ASC 350) Goodwill arises from acquisitions where the purchase price exceeds the fair value of identifiable net assets.
  • Long-Term Investments: Investments in stocks, bonds, or real estate intended to be held for over a year.
  • Other Assets: Items like long-term notes receivable or deferred tax assets.

Proper classification helps assess short-term liquidity and long-term operational capacity.

Listing Liabilities

With assets categorized, attention shifts to liabilities – amounts owed by the business to external parties from past events, requiring a future outflow of resources. Like assets, liabilities are separated into current and non-current categories based generally on a one-year or operating cycle timeframe. A liability is current if expected to be settled within this period, held for trading, due within twelve months, or if the entity cannot unconditionally defer settlement beyond twelve months.4Deloitte Accounting Research Tool. ASC 470-10: Debt – Balance Sheet Classification – General

Current liabilities are short-term obligations due within one year or the operating cycle. Common examples include:

  • Accounts Payable: Amounts owed to suppliers for credit purchases.
  • Accrued Expenses: Expenses incurred but not yet paid (e.g., salaries, interest, utilities).
  • Short-Term Notes Payable: Formal loan agreements due within the year.
  • Current Portion of Long-Term Debt: Principal payments on long-term debt due within the next twelve months.
  • Unearned Revenue: Cash received from customers before goods or services are provided.
  • Income Taxes Payable: Corporate income tax owed to government authorities.

Obligations not meeting current criteria are non-current or long-term liabilities, due more than one year or operating cycle from the balance sheet date. Examples include:

  • Long-Term Notes Payable / Bonds Payable: Formal debt instruments issued to raise capital, reported adjusted for any premium or discount.
  • Mortgage Payable: Long-term loan secured by real estate.
  • Deferred Tax Liabilities: Often arise from temporary differences between book and tax accounting.
  • Lease Liabilities: Obligations for future lease payments under standards like ASC 842 and IFRS 16, often split between current and non-current portions.5PwC Viewpoint. Leases Guide (ASC 842): Lessee Balance Sheet Presentation
  • Other Long-Term Obligations: Pension plan liabilities or long-term warranties.

Accurate listing provides insight into the company’s financial structure and future cash needs.

Calculating Equity

With assets and liabilities organized, the final component is equity, representing the residual interest in assets after deducting liabilities – the owners’ net worth. The basic calculation is Equity = Assets – Liabilities, but the balance sheet details its components.

Equity primarily consists of contributed capital and retained earnings. Contributed capital is funds invested by owners, mainly through stock for corporations. Common stock represents basic ownership, recorded at par value, with amounts above par recorded as “Additional Paid-in Capital” (APIC). Preferred stock carries specific rights over common stock. Accounting for stock issuance follows guidelines like ASC 505.6PwC Viewpoint. Equity Guide: Accounting for the Issuance of Capital Stock (ASC 505)

Retained earnings represent accumulated profits not distributed to owners. The calculation is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. Net income increases retained earnings; net losses and dividends decrease it. A negative balance is an accumulated deficit.

Treasury stock, the company’s own shares repurchased from the market, also affects equity. It is recorded at cost and shown as a deduction (contra-equity account), reducing total equity. Reissuance adjustments affect equity accounts, not the income statement.

Total equity can also include Accumulated Other Comprehensive Income (AOCI). Comprehensive income includes net income plus other specific gains and losses bypassing the income statement (like certain unrealized investment gains/losses or foreign currency adjustments), accumulating in AOCI. Standards like ASC 220 guide reporting.7PwC Viewpoint. Comprehensive Income Guide: General Reporting Requirements (ASC 220) Summing contributed capital, retained earnings, and AOCI, less treasury stock, yields total equity.

Final Checks

After assembling all sections, final checks are necessary. The fundamental verification is ensuring the accounting equation holds: Total Assets = Total Liabilities + Total Equity. An imbalance signals errors like omitted transactions, incorrect entries, miscalculations, or classification mistakes.

Comparing current balance sheet figures to previous periods is valuable. Presenting comparative balance sheets allows for trend analysis. Significant fluctuations warrant investigation (e.g., a large rise in receivables or a drop in cash). This horizontal analysis helps identify anomalies and assess the company’s trajectory. Accounting standards encourage comparative reporting.

A detailed review of individual line items against supporting documentation ensures accuracy. Reconcile cash with bank statements, receivables with subledgers, inventory with counts, and fixed assets with schedules. Verify correct current/non-current classification. Ensure assets and liabilities are offset only when permitted by standards like ASC 210 or IAS 1.8IAS Plus. IAS 1 — Presentation of Financial Statements

Review the accompanying notes to the financial statements, which provide context and detail. Disclosures should comply with applicable frameworks (GAAP or IFRS), covering significant accounting policies, estimation methods, contingencies, debt details, fair value measurements (guided by standards like ASC 820), and subsequent events.9PwC Viewpoint. Fair Value Measurements Guide: The Definition of Fair Value (ASC 820) Clear and complete disclosures are the final step in preparing a reliable balance sheet.

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