What is a balance sheet?
A balance sheet is a financial statement that provides an overview of a company’s assets, liabilities and shareholders’ equity at a given time. The purpose of the balance sheet is to give stakeholders an idea of the company’s financial position. Lenders and investors typically use it to assess a company’s financial health and borrowers to assess their ability to repay loans.
The balance sheet can be used to evaluate a company’s financial health and make investing decisions. However, it’s important to note that the balance sheet only provides a snapshot of the company’s financial position at a specific time, so it should always be used in conjunction with other financial information.
All balance sheets include three main sections: Assets, Liabilities and Shareholder/owner equity. A balance sheet equation is simple and can be expressed in 3 ways:
- Equity = Assets – Liabilities
- Assets = Liabilities + Equity
- Liabilities = Assets – Equity
So what’s involved?
What are Assets?
A company’s Assets are the resources available (both in the long and short term) to run your business. They include liquid assets such as cash, bank funds, trade debtors, loans to other entities and inventory, as well as fixed assets such as motor vehicles, equipment and buildings. Assets may also include intangible assets such as trademarks and goodwill.
Assets are items and resources that a company owns. They have a current and/or future value that can be measured in currency.
Assets may be subdivided into
- Current Assets, which can be quickly converted to cash if needed, such as bank accounts, inventory, short-term deposits, investments, pre-payments and accounts receivable (trade debtors);
- Fixed (or non-current) Assets, such as motor vehicles, equipment and buildings, and;
- Intangible Assets, such as trademarks, intellectual property, and goodwill.
What are Liabilities?
Liabilities are monies the company owes to the ATO, suppliers and other creditors for goods or services already received but have not yet paid. Liabilities may also include amounts received in advance for future services yet to be provided by the business – this can differ from industry to industry
There are two types of liabilities: current liabilities and long-term liabilities. Current liabilities are expected to be paid within one year, while long-term liabilities are expected to be paid within a year.
- Current Liabilities include overdrafts, credit cards, trade creditors, payroll liabilities (unpaid wages, PAYGW, Super) and ATO liabilities (GST, income tax, FBT),
- Non-current liabilities are longer-term liabilities such as warranties, loans, leases and mortgages.
The primary purpose of recording liabilities on the balance sheet is to provide accurate information about the company’s financial obligations that fall due in the short and longer term.
The Balance Sheet should be reviewed, and key accounts regularly reconciled by a qualified, experienced bookkeeper. The information recorded on the Balance Sheet helps assess the company’s financial health and indicates its ability to meet its obligations when they come due.
What is Equity?
Equity includes owner funds contributed, retained earnings and dividends.
Transactions affecting profit and loss accounts can also affect balance sheet items. For example, providing a service increases the accounts receivable balance (money owed), increasing the company’s Assets and Equity.
On the flip side, taking out a loan or purchasing additional stock increases your company’s liabilities and reduces Equity.
The Balance Sheet Equation
Your balance sheet must always balance! Asset value = liabilities + Equity.
This balance sheet equation shows how much money you would have left if you paid all your bills and debts and sold all your assets on a given date. This amount is the Owner’s Equity.
Note that the balance sheet equity total may differ significantly from how much the business is worth at market value. For example, assets are listed on the balance sheet at their transaction value, which may be very different from the current market value. For example, if you bought a factory in 2002 for $100,000, you’d record the Asset at its purchase price of $100,000 on the Balance Sheet. Some 20 years later, the property value may have increased and now be worth $250,000. Some assets may be worth more, and others less due to depreciation. For example, if you bought a car in 2015 for $25,000 after depreciation, it’s probably worth next to nothing in 2022.
The Balance Sheet provides many key figures to help value your business. However, your Balance Sheet does not include many additional factors, such as market share, market strength, revalued assets, future prospects, staff, location and service contracts, so cannot be solely used to value a company.
Tips for improving your balance sheet
Are you looking to improve your company’s balance sheet? If so, you can do a few things to make it happen. These include:
- Have a professional bookkeeper review and reconcile key balance sheet accounts, bank, credit card, GST, PAYGW, loans etc., to ensure the figures remain accurate.
- Understand the different types of assets and liabilities on your balance sheet.
- Make sure your assets are adequately diversified.
- Review your debt levels and terms regularly.
- Keep an eye on your cash flow.
- Have a contingency plan for unexpected expenses.
Need more information?
The balance sheet is one of a business’s most important financial statements, providing insights into the company’s overall financial health. A strong balance sheet can give a business the flexibility to weather tough times, while a weak balance sheet can constrain operations. By understanding how to read and interpret a balance sheet, you can better understand your company’s financial situation and make more informed decisions about investing, diversifying, expanding or being more restrained.
Contact Numble for assistance with reading, reconciling, and understanding your balance sheet!
Numble offers free consultations to help small businesses understand their financial position and balance sheets! Contact Us today to get the complete picture of your business performance and financial position.
