If you run a business, whether it’s local or nationwide, you’re going to need what is often called a financial statement package, including a balance sheet. A balance sheet shows the assets (what you own), liabilities (what you owe) and equity of your business. But how’s this different from a classified balance sheet?
A classified balance sheet includes additional information of interest to potential investors, buyers or new hires.
In analyzing the financial health of your business, your balance sheet plays an important role. For example, your working capital can be calculated based on the information included in your balance sheet. Working capital is often seen as a barometer of a business’ financial health.
To help make an analysis of your business finances easier, you or your accountant can include additional categories or ‘classifications’ within the larger assets, liabilities and equity sections. When you take this extra step, your balance sheet becomes a classified balance sheet.
What is a classified balance sheet?
In the most basic of terms, a classified balance sheet provides more information than a balance sheet. Thus, it is a fuller representation of the financial status of a company.
This makes classified balance sheets:
- Easier to read
- More digestible
- Able to provide a fuller picture of the financial health of the business
While balance sheets are often created by an accountant, they are rarely analyzed by one. The extra details that are included in a classified balance sheet help potential investors, buyers or new employees better understand where your company stands financially.
A classified balance sheet can also allow an investor or buyer to easily zero in on the specific piece of information they need.
Classified vs. nonclassified balance sheet
As discussed above, the main difference between a classified balance sheet and a nonclassified balance sheet is all in the details. To help you decide which option is best suited for your business, here is how both options are prepared.
What is always included in a balance sheet?
A balance sheet (whether classified or nonclassified) always includes the following information:
- Owner’s equity
When creating a nonclassified balance sheet, you or your account should list out all the appropriate items under the three above categories, as well as the totals. No further categorization is required for a nonclassified balance sheet.
What makes a balance sheet classified?
To turn a nonclassified balance sheet into a classified balance sheet, your business’ assets, liabilities and equity must be broken down into more detailed subcategories.
Here are the most common categories used when creating a classified balance sheet:
Current assets, sometimes referred to as liquid assets, includes anything that can easily be turned into cash.
- Cash equivalents
- Accounts receivables (what’s owed you)
- Prepaid expenses
- Assets held for sale
Fixed assets, often referred to as noncurrent assets, are things you own that are more difficult to turn into cash.
- Equipment (office, production, etc.)
- Computer software
- Improvements to any space you lease
- Long-term investments
Intangible assets cannot be seen or touched; they are not physical items.
- Community, client and investor goodwill
- Trade secrets
- Intellectual property
Current liabilities include any debt you must pay (usually within a year).
- Accounts payable (what you owe suppliers or creditors)
- Deferred revenue
- Accrued compensation/expenses owed to employees
- Taxes due
- Loan payments
- Liabilities held for sale
Long-term liabilities, also referred to as noncurrent liabilities, are obligations that are not due within a year.
- Deferred tax liabilities
- Long-term loans
- Deferred compensation
- Deferred income taxes
For small businesses that are sole proprietorships, owner’s equity represents your ownership or investment in your business.
- Funds you’ve contributed
- Capital paid in by investors
- Retained earnings
- Other income
It’s important to note that while these are the most common classifications or subcategories that you will find included in a classified balance sheet, standards will vary industry to industry.
Once you’ve decided on a classification system, it’s important to apply it consistently.
This way multiple balance sheets over several reporting periods can be easily compared.
When is a classified balance sheet the best option?
A nonclassified balance sheet is likely the right choice for you if:
- You run a small business
- Have only a few line items to report on your balance sheet
- Have no long-term goals to expand or sell your company
Just keep in mind that a nonclassified balance sheet could result in more questions concerning the way you manage your finances.
Classified balance sheets are the better choice in any of the following situations:
- If you currently manage your finances but are thinking about hiring an accountant, a classified balance sheet will make the transition smoother.
- When selling the business, the more detailed balance sheet will help potential buyers better understand your finances.
- If you plan to take on investors, a classified balance sheet leaves no room for interpretation.
In all cases, a classified balance sheet communicates transparency.
Providing financial clarity
As a business owner, there are countless issues and concerns that you need to make a priority.
Maintaining clarity of the inner workings of your finances should be at the top of your list.
From providing a fuller picture of your business’ financial health to ensuring the success of your money management strategy, a classified balance sheet can provide this needed clarity.