What is a Balance Sheet and How do I read one?

The Business Activators network consists of knowledgeable professionals who can assist you with reading and understanding your balance sheet and cash flow statement - two of the most vital documents for running your business proficiently.

Our team is experienced and willing to support your business in understanding its core metrics.

Have a glance at your Balance Sheet

Step 1 - Start by looking at the list of assets at the top of the balance sheet which represent what your business owns.

Step 2 - Then look at the liabilities underneath the list of assets which cover what your business owes and the net Balance is made up of Equity.

Step 3 - You can now use this net information to determine profitability and cash flow.

Why do Companies have Balance Sheets?

A balance sheet is a document that provides a brief snapshot of an organization's financial standing at a given point in time. It summarizes assets, liabilities, and equity into an easy-to-read format. Depending on who is looking at it, the same balance sheet can serve two purposes - one to shareholders and another to stakeholders.

Internal stakeholders can easily get an idea of how a business is performing from the results of internal audits, helping them to make informed decisions.

A company's external information provides potential investors with all the necessary details to make an informed decision. It sheds light on what resources are available to it and how they were funded. This gives them a better understanding of the organization as a whole and whether or not investing in it would be a wise choice.

Through a balance sheet, it's possible to gain insight into the liquidity, profitability, and debt-to-equity ratio of a company. These metrics can be useful in understanding the financial health of the company and reaching business decisions.

External auditors use the balance sheet to guarantee that a business is abiding by all the reporting regulations they are liable to.

Balance sheets are a snapshot of your financials at a certain point of time. This means their information is based on historical data and not real-time. It's key to remember this when interpreting the findings of the balance sheet.

While investors and stakeholders may use a balance sheet to predict future performance, past performance is no guarantee of future results.

What is a Balance Sheet?

A balance sheet is an essential financial statement used to display a company's or organization's financial status at any given point in time. It outlines exactly how much the entity is worth, revealing its so-called "book value." A balance sheet is a financial statement showing the value of a company's assets, liabilities and owners' equity as of a fixed date. This data provides stakeholders with useful insights into the financial state of the organisation at that point in time.

Financial documents such as balance sheets must be created and shared on a regular basis in order to monitor company performance throughout the year. This could be done every quarter or month depending on compliance and business needs.

The Balance Sheet Equation

The information found in a balance sheet will most often be organized according to the following equation: Assets = Liabilities + Owners’ Equity.

While this equation is the most common formula for balance sheets, it isn’t the only way of organizing the information. Here are other equations you may encounter:

Owners’ Equity = Assets - Liabilities

Liabilities = Assets - Owners’ Equity

A balance sheet MUST always balance. Assets must always equal liabilities plus owners’ equity. Owners’ equity must always equal assets minus liabilities. Liabilities must always equal assets minus owners’ equity.

If a balance sheet doesn’t balance, it’s likely the document was prepared incorrectly. Typically, errors are due to incomplete or missing data, incorrectly entered transactions, errors in currency exchange rates or inventory levels, miscalculations of equity, or miscalculated depreciation or amortization.

Here’s a closer look at what's typically included in each of those categories of value: assets, liabilities, and owners’ equity.

1. Assets

An asset is defined as anything that is owned by a company and holds inherent, quantifiable value. A business could, if necessary, convert an asset into cash through a process known as liquidation. Assets are typically tallied as positives (+) in a balance sheet and broken down into two further categories: current assets and noncurrent assets.

Current assets typically include anything a company expects it will convert into cash within a year, such as:

·         Cash and cash equivalents

·         Prepaid expenses

·         Inventory

·         Short Term Investments

·         Accounts receivable

Noncurrent assets typically include long-term investments that aren’t expected to be converted into cash in the short term, such as:

·         Land

·         Patents

·         Trademarks

·         Brands

·         Goodwill

·         Intellectual property

·         Equipment used to produce goods or perform services (Work in Progress)

It is important to develop an understanding of what assets a company invests in to achieve its goals. Without this knowledge, it can be difficult to interpret the balance sheet and other essential financial documents that indicate a company’s financial condition..

2. Liabilities

A liability is the opposite of an asset. While an asset is something a company owns, a liability is something it owes. Liabilities are financial and legal obligations to pay an amount of money to a debtor, which is why they’re typically tallied as negatives (-) in a balance sheet.

Just as assets are categorized as current or noncurrent, liabilities are categorized as current liabilities or noncurrent liabilities.

Current liabilities typically refer to any liability due to the debtor within one year, which may include:

·         Payroll expenses

·         Rent payments

·         Utility payments

·         Debt financing

·         Accounts payable

·         Other accrued expenses

Noncurrent liabilities typically refer to any long-term obligations or debts which will not be due within one year, which might include:

·         Leases

·         Loans

·         Provisions

·         Deferred tax liabilities

Liabilities may also include an obligation to provide goods or services in the future.

3. Owners’ Equity

Owners’ equity, also known as shareholders' equity, typically refers to anything that belongs to the owners of a business after any liabilities are accounted for.

If you were to add up all of the resources a business owns (the assets) and subtract all of the claims from third parties (the liabilities), the residual leftover is the owners’ equity.

Owners’ equity typically includes two key elements. The first is money, which is contributed to the business in the form of an investment in exchange for some degree of ownership (typically represented by shares). The second is earnings that the company generates over time and retains.

Contact Business Activators today to have a chat about how to improve your business financial performance- do you know your 7 levers to success?