How A Detailed Balance Sheet Can Help You Manage Your Business & Achieve Your Goals
If you’re thinking, “I don’t have the time to commit to learning more about my business’ financial health. I have better things to do,” let me stop you right there. Because when it comes to achieving your goals and playing a major role in improving the overall performance of your business, getting a handle on how your business uses its assets and manages its liabilities is critical to growing your business.
A balance sheet is one of many closely watched financial reports that help businesses understand their overall financial health. While your income statement details the past activities of your business, your balance sheet highlights its current overall financial health. Because a balance sheet includes the assets and liabilities of a business at a specific point in time, rather than providing a chronological review like the income statement, it can offer an instant snapshot into the key factors affecting a company’s overall financial standing.
Understanding what a Balance Sheet can tell you
When you’re running a small business, having the ability to quickly see your company’s financial health is crucial. A balance sheet can help you do just that.
Tracking and analyzing your assets, liabilities, and net worth (equity) can provide a deeper understanding of your business’s overall financial picture. Someone wanting to manage growth and plan for future needs for the company can use this information. Lenders also use it to determine if they should loan money to you.
A balance sheet is one of the most important financial statements for a business. If you’re running a business without one, it’s time to start creating one now.
How to Read a Balance Sheet
Like all financial statements, the balance sheet has its unique format and terminology that you may not be familiar with at first. Fortunately, reading any balance sheet is usually pretty straightforward once you understand a few key terms and formulas. Let’s start by looking at some of the most common terms used on this financial statement:
The first step is to look at the company’s assets, listed in order of liquidity (how quickly you can convert them into cash).
Current assets can reasonably be converted to cash within one year; they include cash and cash equivalents (money held in savings accounts or short-term CDs), marketable securities, accounts receivable (money owed to your business by customers), inventory, and prepaid expenses.
Non-current assets include:
- Fixed assets like property, plant, and equipment.
- Intangible assets like patents and copyrights.
- Long-term investments.
- Deferred tax assets.
The total of all current and non-current assets should always equal the total assets on the balance sheet.
What makes up liabilities? Liabilities are obligations owed by your business, including short-term debt (less than a year), long-term debt (over a year), accounts payable (money owed to suppliers or other creditors), accrued expenses, deferred revenue (money received for services not yet provided or products not yet shipped), taxes payable, customer deposits, unearned revenue and any other amounts owed.
The shareholders’ equity is the remaining amount of assets available to shareholders after paying debts and other liabilities. The stockholders’ equity subtotal is located in the bottom half of the balance sheet.
Shareholders’ equity is composed of capital stock and retained earnings. Capital stock includes the common and preferred shares issued by a company, including par value and any paid-in capital above par value. Retained earnings are not distributed to shareholders but instead retained in the business.
Examples showing how the ability to read a Balance Sheet can help you
If you’re an investor or shareholder, understanding stockholders’ equity can help you decide whether investing more money into the company makes sense at this time. Looking at retained earnings helps investors determine if a company has enough cash flow to cover its expenses.
A high level of debt compared to equity indicates that a company is highly leveraged and could be vulnerable if it runs into problems repaying its loans. However, high leverage can also produce tax savings if interest payments on debt reduce taxable income.
A balance sheet can also be used to calculate several important ratios that give you an idea of a company’s financial health.
The following are five things that can be learned from a balance sheet using some of those ratios:
- How efficient management is at using its assets to generate revenue.
- Whether or not operating activities generate enough cash to maintain current debt payments and fund capital expenditures.
- If the business has excess cash on hand after paying off its current liabilities.
- Whether or not earnings are sufficient to maintain stable dividend payments to shareholders.
- The company’s cash flow is healthy if it has enough cash on hand to meet short-term obligations.
Ultimately a balance sheet is one of the foundational building blocks upon which your business is based. By creating and following through on a realistic balance sheet, you can unlock the hidden potential of your company’s assets and liabilities, allowing you to achieve unprecedented levels of success within an increasingly competitive marketplace.
And just like that, you can all breathe a sigh of relief. But seriously, now it’s your turn to do the work. If you want your business accounts to be in order, then it’s time to stop procrastinating and solve the problem. If you don’t know where to start, come to Mbugua & Associates and take the first step today.
MA Financial Services Consultants