Business Financial Statements Part 3: Balance Sheet

In the first two parts of our business financial statements, we covered income statements and cash flow and compared them to a ship’s log that shows your voyage—where you’ve been and where you’re headed. The third statement, the balance sheet, shows where your business is at a specific moment in time, much like checking your position on a map to see if you’re on course. 

In this article, the final in our series, we’ll take a closer look at what a balance sheet is, what it shows, and why lenders care about it when you apply for an SBA loan. To help you on your journey to financing, we’ll also give tips on how to get yours ready before you apply for SBA financing. 

What is a balance sheet?

A balance sheet is a snapshot of your business’s financial position rather than a report of activity over a given period. It's built on a simple equation: Assets = liabilities + equity.

Reviewing your balance sheet is a simple way to check whether your business is on course. For instance, even if your business shows positive revenue and healthy cash flow, the balance sheet may reveal that your business has taken on more debt than it can comfortably manage.

Key elements of a balance sheet

A balance sheet is built from three key elements: assets, liabilities, and equity. Together, they show what your business owns, what it owes, and what's left over. Here's what's included in each.

• Assets are everything your business owns, including cash, inventory, equipment, property, and money owed to you (accounts receivable). They're listed in order of liquidity and split into two categories:
  
  • ‍Current assets can be converted to cash in a year or less.‍
  • Non-current, or long-term, assets include real estate, machinery, or equipment. Because these assets depreciate over time, it's important not to overvalue them on the balance sheet.‍‍
• ‍Liabilities are what your business owes, including loans, credit lines, unpaid bills (accounts payable), and other debts. Like assets, they're split into two categories:‍
• Current liabilities are due within a year and include portions of long-term debt, interest payable, wages, and accounts payable.‍
• Long-term liabilities include long-term debt, pension fund liability, and deferred tax liability, among others.‍
• Equity is the owners’ and shareholders’ stake in the business, or what's left over after subtracting liabilities from assets. When the business is profitable and the owner reinvests earnings, equity grows. When there are losses or owner withdrawals, equity shrinks.

Why lenders look so closely at your balance sheet

Lenders look at your balance sheet to see how much of the business runs on debt versus the owner's investment. But they don’t stop there. They also use it as a jumping off point for more calculations that help them assess your business’s financial health. 

• Current Ratio (or Working Capital Ratio): This calculation looks at your company’s current assets compared to liabilities due in 12 months or less and may also take inventory history into account. While it varies by industry, the SBA generally prefers a ratio of 1.25 or higher.
• Quick Ratio (or Acid-Test Ratio): This comparison subtracts inventory from current assets and compares that number to current liabilities. While it varies by industry, the SBA is looking for 1.00 or above. 
• Debt to Tangible Net Worth: This ratio shows your company’s debt compared to the company’s tangible net worth—the worth of the company without intangible assets like copyrights, patents, and trademarks. While this can be tougher to estimate, shoot for a target ratio of 4.00 or lower.  
• Inventory Turnover: This metric shows the average length of time units stay in inventory. Turnover rates vary between industries, so you may need to explain the norms in your situation. 
• Aging Reports: Accounts payable and accounts receivable aging reports organize the balances to be collected or paid into 30-, 60-, or 90-day categories. For any significant balances that are 60 days or more, lenders need to understand whether or not it’s normal for your industry. 

All of this information gives lenders a better sense of what collateral might be available and how much cushion exists if your revenue slows down. 

How to prepare your balance sheet for a business loan application

Your balance sheet shows lenders where your business stands at the time you apply, and these tips will help you get it ready for your loan application.

Update and reconcile it regularly

A balance sheet is only useful if it accurately reflects where things stand right now. Accounting software can generate one automatically, but it's only as accurate as the records behind it, so it's worth checking in regularly. You should also check it against your bank statements to make sure everything lines up. If your records need a bit of cleaning up, a bookkeeper or accountant can help.

Categorize assets and liabilities correctly

Sort your assets and liabilities into current and long-term categories. Getting this organized makes it much easier for lenders to evaluate the balance sheet. 

Have multiple years of history ready

While lenders need to see how the business is doing now, you should also have 2 to 3 years of balance sheets for review, if possible. This will help lenders see the bigger picture and catch anything unusual early, before it becomes a problem later in the process.

Talk to your lender early

Meeting with your lender early can ensure that the balance sheet is set up correctly, streamlining the application process later. 

Mistakes that slow you down

To make your balance sheet as accurate as possible, make sure to avoid these common mistakes:

• Letting your balance sheet get stale between updates
• Liabilities that are missing or recorded in the wrong category, especially informal loans from owners or family
• Overvaluing assets like inventory or equipment
• Not separating personal and business assets
• Treating your balance sheet as a one-time document instead of something to revisit regularly

These mistakes aren’t automatic disqualifiers, but they can slow the approval process down. We’ll help you identify any of these mistakes and help you fix them, so you can move closer to approval. 

Chart your course with a clear balance sheet

A strong balance sheet builds lender confidence and shows that you’re managing your business resources thoughtfully. It also allows the lender to calculate necessary ratios to learn even more about your business.

When you apply for SBA funding, the balance sheet is used in combination with the income statement and cash flow statement—the other financial documents in this series—to give a full picture of your business’s financial health. And, like the ship’s log that we mentioned in the beginning, they show how your business weathers storms and sails through calm periods. 

If you have questions about your balance sheet or how to get it ready for a loan application, just reach out. We’re happy to walk you through it and support you on your journey to approval.