Breaking down your balance sheet

reading-balance-sheet

Small businesses generally pay attention only to their profit and loss statement (P&L). That statement certainly contains important information, and indicates where money is coming from, and how money is being spent. However, that’s only part of the picture.

I like to compare the two statements to personal health: the P&L tells you how the workout went; the balance sheet reflects the overall health. One line on the balance sheet talks about the workout, and the rest of it reflects the assets and liabilities of the company.

The assets and liabilities show how solvent the business is. Before banks will loan money for something like operating capital, they’ll want to review these elements of your company.

Ideally, the balance sheet will show long-term liabilities balanced with long-term assets. That shows that the business is positioned with assets that can offset any money it owes in the future, making it a safer loan for the bank.

There are three main aspects of a balance sheet that every business owner should be aware of.

Assets

On a balance sheet, assets are divided into current assets, other current assets, and long-term assets.

Current assets include liquid assets, such as cash, checking, and savings accounts, as well as other current assets, such as accounts receivables. The cash accounts are already, well, cash, and the idea is that other current assets can quickly be converted to cash. If needed, accounts receivables can be collected in short order, or sold if necessary.

Long-term assets are assets that last over one year, and are not as easily converted to cash. Examples would be furniture, buildings, or land that you own.

Liabilities

Liabilities are the opposite of assets: it takes cash to pay them. They are also grouped into current and long term categories.

Current liabilities include payroll and sales tax payable, trade accounts payable, and credit cards. A 90-day note or the current year’s portion of a long term loan would be captured in other current liabilities.

Like long-term assets, long-term liabilities are those that last over a year. Examples of this would be a Promissory Note, or a loan for the purchase of a building.

Equity

Equity is what is left over when you deduct your liabilities from your assets, and hopefully that’s a positive number! Any contributions to or withdrawals from the company’s funds are recorded in the equity section. Sole proprietors almost invariably have both contributions and draws.

Understanding how to read and interpret a balance sheet as well as a profit and loss statement will help you measure the health of your company more accurately.

These are the key indicators of your business health. Following them will help you make sound future financial decisions for your organization.

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