Basic Financials 101 – Part 2: The Balance Sheet Report
In Part 2 of our Basic Financials series, we’ll cover the Balance Sheet Report This article is an easy to understand guide to provide you with a better understanding of how to gauge your business’ financial health.
Why It’s Important for your Business
Of the financial reports that you should familiarize yourself with, the Balance Sheet Report is arguably one of the most essential. This report is an indicator of the financial health of your business at a specific time – usually at the end of a month, quarter, or year. Basically. It gives you an overview of your business’ net worth. When trying to secure financing or outside investors, this report shows your ability to meet financial obligations as well as investments made into the business by partners or equity owners. A thorough understanding of this report will make it much easier to sell or grow your business in the future, trust me.
Sections and the Basic Sub-categories
The Balance Sheet Report report is broken down into two major sections:
- Assets – Objects of value your business owns.
- Liabilities – What you owe to others.
- Equity – Money attributable to partners or shareholders.
The report is referred to a “Balance” sheet because the two sections must equal each other:
Assets = (Liabilities + Equity)
These sections of the balance report sheet can also be broken into subcategories, just to make the report clearer. Otherwise it would just be a jumble of numbers without much context.
- Current Assets – These are bank accounts, Cash, Accounts Receivables, inventory, loans to employees,etc. These are things that could be readily converted to cash.
- Fixed Assets – This includes buildings or equipment. These are tangible things that your business owns. These may depreciate or appreciate over time.
Liabilities & Equity
- Current Liabilities – Things like accounts Payable, credit card balances, loans, customer deposits, tax liabilities, or other payroll liabilities. These are debts that you owe, or revolving lines of credit that will be paid for over a short period of time, usually within 12 months.
- Long Term Liabilities –These include long-term loans, equipment financing, mortgages, etc. These are debts that you owe that will be paid over an extended period.
- Equity – These are shareholder investments, net profit, retained earnings (previous year net profit reinvested into the company). When it all comes down to it, this is the difference between Assets and Liabilities. (Assets – Liabilities = Equity.)
Here is an example of what a balance sheet looks like:
In Part 1 – The Profit & Loss Report, I warned that business owners often get confused when their Profit & Loss report shows a net profit that differs significantly from the amount of cash in the Bank. The reason for this is because the cash your business has on hand is used to payout expenses as well as payments against liabilities. When the liability payment is posted to the accounting system, that amount offsets the balance of the liability account – and does not appear on the profit and loss report.In Part 3 of this series we will look at the Statement of Cash Flows report, which explains how changes in balance sheet accounts and income affect cash.