If you're like most small business owners, you cringe when it comes time to take a look at your company's balance sheet. But by understanding and using your balance statement, you can make important decisions that will improve your profitability. This post will explain what a balance sheet is and how to use it to make informed business decisions. Stay tuned for future posts where we'll dive deeper into each section of the balance sheet. For now, let's get started!
What Is a Balance Sheet?
The balance sheet is an accounting statement of what your company owns (assets) and owes (liabilities), along with the owner's Equity. A balance sheet represents a snapshot in time, showing how much you own and owe at any point in time. For example, if you are looking at your November 2021 balance sheet, it will show the assets you owned as of November 1st, 2021. Still, it won't show any changes that have occurred since then - meaning that your December 30th balance sheet won't tell you about what happened during December or on January 2nd. Your business's financial health can be judged by its ability to generate enough cash to meet current while still providing for future growth. The balance sheet is the best place to start getting a handle on where your company is, and it can help you spot potential problems.
What Goes Into a Balance Sheet?
The basic structure of a balance sheet includes assets, liabilities, and owner's Equity. Each section highlights an essential aspect of your business financials. Do these seem familiar? They should! They are the parts that make up the accounting formula; assets=liabilities + owner's Equity.
Your assets are what you own that have a monetary value. For example, these include cash or other liquid investments (like stocks or bonds), furniture and equipment, inventory, accounts receivable (money owed to the business from customers), prepaid expenses (expenses paid in advance such as insurance premiums), etc. Assets are listed on the balance sheet in liquidity, meaning they're either cash or will be quickly turned into cash. Owner's Equity, this section includes your investment in the company. The amount representing the owner's Equity varies depending on whether it's a sole proprietorship, partnership, or limited liability company (LLC) or corporation. In broad terms, the higher this number goes, the more confident creditors feel getting their money back since they know your financial assets are on the line. For sole proprietorships and partnerships, the business's net income (or loss) is listed in this section for each year.
You can use a balance sheet to keep an eye on whether or not your business is healthy financially. If the net income number starts to go down or if you notice that your total assets are staying the same or going down, it may be time to sit down and look at what's happening.
What Can Go Wrong?
If your business experiences a downturn, the numbers on your balance sheet will be affected. The change in numbers can mean that one section of your balance sheet will start hurting another part. For example: If you find yourself with less cash (your assets) but still need to pay bills (your liabilities) for inventory and equipment purchases (factored into both sides of the equation), then your owner's Equity will suffer as well - significant drop! You'll want to make any immediate changes needed to maintain healthy numbers across the board - whether that means tightening your budget or finding another source of funding.
A complete balance sheet includes a current assets section, a fixed assets section, and a current liabilities section. It also shows the owner's Equity as either a negative number (representing the amount the business owners have invested) or a positive number (indicating how much more the business is worth than what it owes). In addition to helping owners make important financial decisions concerning their company, balance sheets are used by banks and other lenders to determine if they will offer startup companies loans. As part of this process, each new business must provide particular financial statements, and the balance sheet is one of those required documents.
We've discussed what a balance sheet is and how it's used. We'll be exploring each section of the balance sheet in more detail in future posts, so stay tuned! If you're still not sure where to start or have any questions about your company's financial health - shoot us an email at cedmondson@clebookkeeping.com for help with all things accounting-related.
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