Many people may have financial statements or a balance sheet in front of them, but they do not know what they should be looking for. The financial statements can be seen as a maze as there is so much information and people do not know where to start looking first.
While the balance sheet report reflects assets, liabilities, and shareholder’s equity, it is one of three essential financial reports that, when taken in together, provide a holistic picture of the financial health of an organization. The other two statements are the Income Statement and the cash flow statement.
The balance sheet provides insights on what the business owns (its assets), what the business owes (its liabilities), and how much the business is worth for a particular period of time. It helps you spot the strengths and weaknesses in your business, helping you make smart decisions about how to invest and grow in the future.
In a balance sheet, there are three main components with sub-components listed in order of liquidity:
Assets are what the company owns and uses for its operations. It includes tangible and intangible assets. The assets of a company can be divided in two sub-categories:
Current Assets are assets that can be converted into cash within a period of one year or less.
Non-Current Assets are assets that cannot be converted within a period of one year.
Liabilities are what the company owes and need to pay to complete their obligations. The liabilities of a company can be divided in two sub-categories:
Current Liabilities are obligations that needs to be fulfilled within a year.
Non-Current Liabilities are obligations that needs to be fulfilled after one year.
This refers to the sum of money that is generated by a business and how much is put into the business by shareholders. The equity section is commonly divided into the following sections:
The following two examples will help you understand the basics. The key is to always be in balance!
Brian, the owner of the above company decides he wants to finance a brand new $45,000 SUV. Because the car is valued at $45,000, we will add this amount to the asset side under the account “Vehicles” and add the outstanding debt to the liabilities side, as seen below.
Let’s say Brian wants to pay off his credit card balance. He will need to pull the funds from his cash account. Because the credit card balance is at $5,250 both the cash and credit card accounts are reduced by this amount. Notice that even though Brian’s cash levels decreased by over $5,000, the owner’s equity value of the business didn’t change. The payment simply decreased funds from the asset side (cash) to pay off a liability (the credit card) with no effect to the amount of equity Phil had in the business.
Understanding these basics are foundational to interpreting what the numbers mean. There are some simple financial ratios that can be used to gain a deeper understanding of the balance sheet. The most common include the following:
The balance sheet provides an idea of the company’s financial position, indicates whether the business is profitable and helps to determine what actions, if any, need to be taken to improve the company’s performance. When used in conjunction with the other financial statements it enables business owners, investors and bankers to gather an understanding of the overall health of the company. If you are looking to take your business to the next level Apex CPAs can help. Reach out today to our Business Advisory team!