As a small business owner, you know how important it is to make the most of every tool that’s available to run a better business. That’s why every entrepreneur should be taking advantage of the balance sheet. What is a balance sheet and why should you care?
A balance sheet is one of the three financial statements that, taken together, give you a picture of the overall financial health of your business. (The other two financial statements are the cash flow statement and the profit and loss statement, sometimes called the income statement.)
Why is a balance sheet important?
It may help to think of your business’s balance sheet as a scorecard or report card that shows the status of your business’s finances at a given moment in time. The balance sheet records your business’s assets, its liabilities, and the owners’ equity (also called shareholders’ equity) in the business.
What is a balance sheet’s purpose? It can do several valuable things for a small business owner.
- A balance sheet shows you the big picture. When you’re running a business today, it’s easy to get focused on whether cash is coming in or not, whether you can pay your bills, and if you’re making payroll. A balance sheets goes beyond this short-term view to show your business’s progress over time.
- A balance sheet helps you measure the value of your business. You may not be planning to sell your business anytime soon, but having an idea of its value (that is, the owners’ equity) can give you insight into your options for its future.
- A balance sheet can serve as an early warning system. Between the beginning and the end of the year, is your owners’ equity growing or shrinking? A well-run business should produce growing equity. If your business isn’t doing this, looking at the specific assets and liabilities on your balance sheet can help you find out why. For example, if most of your assets are inventory, that’s risky. Inventory that doesn’t sell quickly becomes a liability.
Components of the balance sheet
A balance sheet has three sections: assets (what the business owns), liabilities (what the business owes, both now and in the future), and owners’ equity (assets + liabilities). Let’s take a closer look at each.
1. Assets
Assets include current assets, fixed assets and other assets. Current assets include:
- Cash
- Accounts Receivable
- Inventory
- Assets that can quickly be converted to cash such as certificates of deposit
Fixed assets are long-term assets that your business will have for more than 12 months. They include:
- Equipment
- Buildings
- Land
- Vehicles
You may also have intangible assets, such as trademarks or patents.
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2. Liabilities
Current liabilities are those that need to be paid within the next 12 months, such as:
- Accounts payable
- Taxes
- Payroll
- Debt service
- Credit card payments
Long-term liabilities will not be paid within the next 12 months. These include:
- Outstanding loans (minus the current portion of these debts)
- Mortgages
3. Owners’ or shareholders’ equity
Add together assets and liabilities to arrive at your owners’ equity or shareholders’ equity. Ideally, this should be a positive figure, but if things aren’t going well, it could be a negative number.
If your owners’ equity remains negative, it will affect not only your profitability, but also your ability to get capital from lenders or investors. Financing sources want to see that a business is doing well enough financially to service its debt or make a profit for investors before they will put any money into your business.
So, what is a balance sheet?
While it may sound like overkill if you are a one-person company or a very small business, a balance sheet is actually a valuable tool for businesses of all sizes to monitor their progress and see how they’re doing.
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