What is the Balance Sheet?
The Balance Sheet is a picture of your business at a point in time. It details assets, liabilities and owners’ equity. Arguably the most important of the financial statements it shows the financial position of the company and can be used to determine where the funds will come from to operate the business or make payments to creditors and owners. Total assets will equal total liabilities plus equity. One way to look at this, the business will invest funds received from liabilities and equity into the assets of business and then use those assets to generate income.
Structure
Assets
Assets are things a company owns or that are owed to it. Assets include cash or bank accounts, amounts receivable from customers and others, inventory, and fixed assets like equipment, furniture, land and buildings. Assets may also include intangible items like goodwill, patents, and copyrights that have value to the business.
Assets are listed first in the balance sheet and they are listed by how quickly they can be converted to cash. Current assets are things that can be turned into cash within one year and includes Cash and bank accounts, investments, accounts receivable, and inventory. Non-current assets are those items that the entity does not intend to convert to cash within a year and include fixed assets less an allowance for depreciation, any long-term receivables, and the value of intangible items.
Liabilities
Liabilities are those amounts that the business owes to others and are listed based on when they are payable. Current liabilities, due within one year include accounts payable, credit card balances, withheld employee taxes and benefits, and any other items due within one year. Long-term liabilities are those due more than one year away. Examples are loans and mortgages.
Equity
The Equity or capital section doesn’t have a term and is different depending on the type of entity but look for Capital Paid In, Retained Earnings which is the sum total of earnings less distributions to date, Distributions or dividends paid to owners, and current year net income. Total Assets less liabilities equals the equity, or the accounting value of the business to the owner
Format
The most common format of the balance sheet is to start with the assets, broken down into sections based on current assets and non-current assets. These categories are further subdivided to suit the needs of the entity. The assets are totaled at the bottom of this section. Liabilities and equity are presented below in separate sections with their own subheadings and totals, but they are totaled together at the bottom and are equal to or balance to the total assets. Another presentation is to list the assets on the left side of the statement and liabilities and equity on the right side. Again, showing that the balance sheet “balances” in the totals at the bottom.
Since the balance sheet is snapshot of a company at a point in time only one column of information as of the end of the period being reported is needed. The prior year information as of the same date is generally reported along with columns showing the dollar and or percent change from the prior year.
Using the Balance Sheet
The balance sheet shows the position of your business. First look should review the entity’s ability to fund immediate operating needs. Considering the information from the income statement should you increase/decrease financing, scale up or down purchases, how best do you finance operations?
Comparing this year to last year or budget may also offer useful information. Is your business moving in the direction you want? Are situations developing that present opportunities or need managing. On the Liability side look at the level of the payables and the total Debt. The income of the business has to pay back the debt and the principal is not reflected in the income statement. I have heard the question many times “My business is making a profit, but it doesn’t feel like it. There is no money left over”. This is frequently because there are so many loan payments or past due bills to pay.
The balance sheet is also a significant source of internal control. Each account listed should be reconciled on a periodic basis to ensure that all activity is being properly recorded in the books. For many accounts this will be monthly, for others quarterly or perhaps annually for very low activity accounts.. Best practice is for reconcilement to be performed by someone different than the person posting the accounts. A general review of the accounts for reasonableness can go a long way. Certain accounts should go to zero on a monthly basis. Make sure that happens
Like the Income Statement, comparing Balance Sheets from different periods can be educational. You can determine where cash in excess of expenses is going or where funding for a shortage of income is coming from. Are customers taking longer to pay, are you taking longer to pay, and if so, what is the result. The goal is to identify and solve problems while they are little
Watching Financial Statements that have been accurately and consistently prepared will keep you on top of your business operations and focused on one of the most important parts of having your own business.
There is more to financial statements than just getting them prepared. I have helped business owners use financial statements to understand and manage their business for a long time. Be happy to talk with you about yours.