Businesses can have the ability to produce revenue, as shown on a P&L (profit and loss statement), but poor financial health, as reflected on the balance sheet. Because it summarizes net worth at a moment in time, a balance sheet is a very useful–and underutilized–business tool. Start putting your balance sheet to work with these tips.
Assets, Liabilities and Equity
The net-worth of a business at any moment in time is an important measure of financial health, and therefore a useful tool to inform day to day decisions. Understanding the
balance sheet is essential to knowing whether or not you are “in the red,” with liabilities exceeding assets:
The balance sheet summarizes your business’s financial status as of a certain date. It follows the accounting equation: Assets = Liabilities + Owner’s equity. In non-accounting terms, the balance sheet tells you what your business owns (assets), what it owes (liabilities), and what the owner’s stake in the business is (equity). If you think of your financial statements as the story of your business, then the balance sheet serves as the CliffsNotes version of that story. Every transaction in your business impacts the balance sheet in some way….The balance sheet is an essential tool to help you — and potential investors — analyze your company’s health at a glance and make sound business decisions….You can quickly analyze your business’s financial health with a glance at the balance sheet. If equity is negative — meaning liabilities are greater than assets — that could indicate your business is in financial trouble.
Regularly analyzing the balance sheet, and the changes reflected on it as the year progresses, gives business owners intel to use in real time. Specifically, balance sheets provide information about the current state of assets, liabilities and equity:
- The assets section of your balance sheet lists out the various assets that your business owns, including your cash, receivables due from customers and others, inventory, and fixed assets.
- The liabilities section of your balance sheet lists out what you owe to others, whether it be to your suppliers, your bankers, government agencies, related entities, etc.
- The equity section of the balance sheet represents the owner’s value in the business. This section will show money contributed to the business by the owner, money taken out of the business by the owner, and retained earnings. Retained earnings are those earnings from prior periods.
Importantly, balance sheets also provide information about how long it will take to convert assets to cash should doing so become necessary: “Examples of current assets are cash, accounts receivable, inventory, and other short-term assets. Long-term assets are those assets that will take longer to convert to cash. These are items like buildings, equipment, and vehicles….” Of course, business owners want to avoid financial emergencies that lead to a rush to unload hard-won assets, which is another reason why regular and careful analysis of the balance sheet is so key to running a successful business:
You should understand every account on your balance sheet and each balance represented. And, you should look to see improvements in your balance sheet each month….A healthy balance sheet will have more assets than liabilities. If your total assets equal more than your liabilities, then you can have some level of comfort, knowing that you have enough cash, or things that can easily be turned into cash, to pay off your liabilities. If your total assets balance is less than your total liabilities balance, your business doesn’t have enough assets to cover its liabilities. You’re highly leveraged. If you had a slowdown…you would struggle to meet your payment obligations…..Bankers, investors, and potential acquirers use the balance sheet to evaluate the health of the business. You may have a strong-looking P&L, but if you are managing your cash and resources poorly, your balance sheet will show it.
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