Running a business, even a small one, is already hard enough without throwing in statistical business reports in the mix. However, these reports, like a balance sheet, are the key to achieving a successful venture. Whether you are an entrepreneur, an investor, or an executive, you need to understand financial statements, as they are the lifeline of your business and finances.
Business always comes with substantial risks, but some risks are avoidable if you just paid enough attention to your financial reports. According to Insurance Quote, 29% of small businesses fail because they run out of cash—a problem that would have been prevented by diligently tracking your financial statements.
One such significant financial report is the balance sheet. Among the five significant financial statements (the four being income, cash flow, stockholder’s equity, and comprehensive income statements), the balance sheet is a crucial report to understand and analyze if you want your company to grow and strengthen its financial position in the industry. It is more than just ratios and raw numbers on a piece of paper. Here are the basics that you need to cover about balance sheets.
Understanding The Balance Sheet
Also known as the “statement of financial position”, a balance sheet is a statistical report bearing a company’s calculated assets, liabilities, and owner’s equity or net worth. It shows the firm’s financial standing over a specified time. The balance sheet, together with income and cash flow statements, are the foundations of a firm’s financial statement.
Most businesspeople describe it as a “snapshot” of a company’s finances for it tracks its spending and earning at a point in time. Balance sheets always come with financial details and reports from the previous years. Without them, you cannot do a comparative analysis of your company’s performance and see which parts you need to improve.
A balance sheet comprises:
Assets are any tangible or intangible items of value that your firm owns. In the sheet, assets are listed in chronological order (top to bottom) based on liquidity or their ability and ease to be converted into cash. They are separated into current and fixed assets. The general order of assets that can be seen on the sheet are:
- Cash – including hard currency, short-term deposit, and Treasury bill.
- Marketable securities
- Accounts receivables – any cash owed by customers to a company for lending their services or goods.
- Inventory – refers to a company’s finished products that are currently on-hand and for sale.
- Prepaid expenses
- Long-term investments – items that cannot be converted into cash the following year.
- Fixed assets – pieces of equipment, machinery, or land that a firm uses to sustain its operations.
- Intangible assets – include copyrights, patents, and franchise agreements. These assets are only included in the sheet if they have a definite lifespan and an identifiable market value.
Liabilities represent a firm’s payment obligations to outside parties. It is categorized into two: current liabilities, which refers to money owed that is due within one year, and long-term liabilities are amounts with more than one year to pay. Examples of current liabilities are:
- Bank indebtedness
- Interest and wages payable
- Customer prepayments
- Dividends payable
- Earned and unearned premiums
- Accounts payable
While long-term liabilities include long-term debt, pension fund liability, and deferred tax liability.
What is Equity?
Equity or net asset is the company’s total amount of assets minus its liabilities, or the money it owes to third parties. If you are the sole owner of your company, then it is referred to as the owner’s equity. But for a corporation, it is called a stakeholder’s equity.
Equity consists of retained earnings and paid-in capital. Retained earnings are earnings used by the firm to either pay off debts or reinvest back into the business. After that, the remaining gains would be distributed to the stakeholders as dividends (an act known as paid-in capital).
Ultimately, balance sheets help your company make sound financial decisions and foresee potential financial problems. It can help you qualify for a bank loan or credit and help you gain investors and retain current ones. A balance sheet is an analysis that reveals a firm’s operational efficiency, profitability, and liquidity. Knowing your financial standing in the industry helps you assess your company’s sustainability and make long-term business plans. Annette Ferguson – a Chartered Accountant and Certified Profit First Professional – can assist you in unlocking financial strategies to boost business profitability. Book a call with us. You can also follow us on any of our social media channels and subscribe to our YouTube channel.