How Balance Sheets Can Keep You Out of Financial Trouble
Yes, I know. Most small business owners don’t get real excited when it comes to talking about accounting reports for their business. After all, there are so many other important things to do, who has time for that?
Well, you should.
Your balance sheet gives you an at-a-glance picture of your company health. And if your company isn’t healthy, that’s not a good thing.
Think about it this way. Your balance sheet is the big picture view of what’s going on in your company. It’s called a balance sheet because it shows a balanced view of your assets, liabilities and equity.
Here’s an example.
It’s not just a jumble of numbers. There’s a method to the madness and it’s based on a very simple formula.
Total Assets = Liabilities + Equity
Easy, huh? Your balance sheet may have different components depending on how your books were set up initially, but the idea is still the same. Here’s a breakdown of the entries.
Let’s look at the assets section first.
Items that can easily be turned into cash are called current assets. In addition to the cash you have in your bank account, current assets also include those items that are cash equivalents like accounts receivable and inventory.
Fixed assets include tangible items you use in your business, like your computer, to produce income for your company.
You may also have intangible assets. This includes things like your website domain, copyrights, trademarks, and business methods. These would be included beneath fixed assets on the balance sheet if they apply to your company.
For this section of your balance sheet, the most liquid assets are listed first, followed by less liquid items, in order of how easy it would be turn them into cash. The typical order is current assets, fixed assets, and then intangible assets.
That completes the asset side of your balance sheet.
Now let’s look at the other side.
Liabilities are obligations owed by the company.
Current liabilities include accounts payable and other short-term debts like taxes. Current liabilities are always paid with current assets, so it’s important to have enough assets to take care of liabilities. A good rule of thumb is to have two and a half times more assets than liabilities.
Long term liabilities are obligations that will be paid in a term longer than one year.
Equity, also known as net worth, is determined by subtracting liabilities from assets.
How Your Balance Sheet Can Reveal Your Business Health
It’s important to remember that your balance sheet is just a snapshot in time. It’s a good idea to compare your current balance sheet with past reports to help shed light on what’s happening in your business.
Here are a few things to consider:
- Does your business have enough liquid assets to cover operating expenses?
- Do you have flexibility with your assets to allow for business changes (such as an unexpected expense)?
- Are your numbers trending in a certain direction (up or down) and what action can you take to correct the situation if needed?
- Can your current path be sustained to carry your business into the future?
To do that, you should run the report with a comparison to a past period. For example, if you wanted to see how you were doing this month compared to last month, your report might look like the sample below.
There are three important changes from last month to this month in this example.
- Your liquid assets (checking account) have increased, because
- You were able to collect on many of your receivables, and
- You paid down your credit card debt.
So there you go. See, I told you it was simple. This report should be generated automatically by your accounting software. It’s a good idea for you to take a look at it regularly so you have a handle on your financial health and can use the information to help you make the right decisions to keep your business in a sustainable position.
Don’t have a balance sheet? Download this free balance sheet template.
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