Are you making the most of your business’s balance sheet? If your answer is “What’s a balance sheet?” you’ve got some catching up to do. However, even if you or your accountant create balance sheets on a regular basis, you may not be using your balance sheet to the fullest.
A balance sheet is more than just a spreadsheet to file away with your financial documents. It can help you in many ways. In this post, I’ll explain what a balance sheet is, the components of a balance sheet, and how to use a balance sheet.
How to do a balance sheet
A company’s balance sheet is one of its key financial statements, along with the income statement and the cash flow statement. The balance sheet shows the company’s assets, liabilities, and equity at a given point in time. It’s called a balance sheet because assets and liabilities balance out to arrive at the owner’s equity.
1. Assets
Current assets are cash or assets that can easily be converted into cash. They include:
- Assets that will be converted to cash within the next operating cycle (such as raw materials used to manufacture products)
- Short-term investments
- Accounts receivable
- Inventory
- Long-term investments
Fixed assets are assets you’re not planning to convert into cash (such as equipment, company cars, or your physical plant)
Other types of assets include:
- Intangibles (goodwill, patents, and franchise agreements are all examples of intangible, but still valuable, assets)
- Miscellaneous (assets that don’t fit into the above categories)
2. Liabilities
Current liabilities are those due within the next 12 months. These include:
- Accounts Ppyable
- Taxes
- Short-term loan payments
You should also include long-term loan payments, such as a mortgage on the building where your business is located.
3. Owner’s equity
Your business’s assets plus its liabilities add up to the owner’s equity. If your business is incorporated and some of the equity belongs to your shareholders, remember that they’re owners, too.
What to pay attention to on your balance sheet
Because they look out over a 12-month period, balance sheets are a good way to get a long view of your business’s financial situation. With your balance sheet at hand, you can run some numbers that will give you an indication of your business’s overall financial health:
Current ratio: Divide current assets by current liabilities; this number should be at least 1.0 and ideally closer to 2.0.
Debt-to-equity ratio: Divide total liabilities by owner’s equity; the lower this ratio is, the better.
And here are questions to ask yourself about your balance sheet:
- Is the bulk of your assets inventory? This could be a sign that you are holding too much inventory, which costs money to store and may have to be sold at a loss.
- How much of your assets are cash or current assets? If you don’t have access to ready cash, this can cause problems for your business. For one thing, you won’t have money to invest in growth or expansion.
- Are you collecting on your accounts receivable in a timely fashion? Assets you don’t have in hand can’t contribute to your business.
What can you learn from a balance sheet?
A balance sheet gives you a full picture of your business’s finances, one that takes into account all of your assets and all of your liabilities—including those that aren’t part of your cash flow statement. With this birds-eye view of your business, you can make necessary changes, such as:
- Adjusting your purchasing process and inventory management
- Converting more of your assets to current assets
- Improving your collections methods to get paid on time
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A balance sheet is also essential if you’re trying to get a business loan from a bank or capital from investors. Here are some things potential financing sources will look at on your business statement:
- Are you retaining enough earnings in the business? If you’re distributing all of your profits, bankers and investors will worry that you don’t have enough of a “cash cushion” to get you through a downturn.
- Are your financial statements professionally done? While you can create your own balance sheet (and you should definitely know how to read your balance sheet), if you’re looking for capital, have an accounting professional prepare this and all of your financial statements. Aside from saving you time, professionally prepared financial statements are considered more reliable than those generated inside a business.
- Do you have skin in the game? A balance sheet may reveal that your business relies too heavily on lenders or investors. If you don’t have a reasonable amount of owner’s equity, financing sources may doubt your commitment to the business should things get rough.
What’s your business worth?
Ultimately, a balance sheet calculates the value of your business. Even if you aren’t planning to sell your business in the near future, think of it as a way to keep score.
You may find out your business is less successful—or more successful—than you thought it was. Most people greatly overestimate the value of their businesses, so getting a reality check can be helpful. By pinpointing shortfalls in your business’s finances, a balance sheet can help you make long-term changes that will improve your company’s chance of success.
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