Believing that revenue and expenses comprise everything you need to know about your business is a concept that’s past its expiration date. Familiarity with the Balance Sheet is a habitual practice of entrepreneurs who are aware of the security derived from comprehending a true state of company strength. They don’t permit profitable operations to legitimize neglect of crucial financial evaluation.
Getting Started
Just as parents maintain constant vigilance over the health of their children, business owners should press deeply into the safety of their enterprises. The Balance Sheet is a tool for investigating the vital signs of your business. Before taking Balance Sheet health readings, you have to know what signals to evaluate. Navigating the components of this financial report must therefore become an unambiguous environment.
The three Balance Sheet areas are assets, liabilities, and equity. Accounts in these sections show the balances on the date of the Balance Sheet. Whereas assets are what the business owns and liabilities are what it owes, equity is simply the difference between these two – the so-called “net worth” of the operation. When your business makes a profit or obtains cash infusion from you or borrows funds, the money from these sources goes into some asset – such as cash. This balances against the increasing new worth or liability.
Further breakdown of assets and liabilities distinguishes their life span. Current assets are all cash and things quickly convertible to cash – accounts receivable and inventory. Items expected to stay on the Balance Sheet for more than a year are fixed assets – like machinery and computers. Similarly, current liabilities are payable in less than one year while long-term liabilities come due in more than one year.
What’s Important
Lots of current assets – like cash – are generally an indicator of Balance Sheet strength. Current assets comprising growing inventory or accounts receivable, however, must be supported by higher sales. Businesses that require plenty of equipment find its depreciated value on the Balance Sheet. Accumulated depreciation is a negative asset that lowers the net value of fixed assets.
If your company is paid immediately by customers and has no need for inventory or equipment, the asset component of your Balance Sheet is nothing more than a bank account. But the operation is certain to have some liabilities. An amount of debt that’s large is typically troubling. A substantial amount of current liabilities ultimately leads to despair. They are typically incurred by small businesses as credit card debt, sales tax owed, and payroll taxes payable.
A few simple key ratios render guidance about Balance Sheet strength. First is the Current Ratio, which is current assets divided by current liabilities. Aim for a result of 1.5 or higher. Another fundamental gauge is the ratio of liabilities to equity. A strong Balance Sheet will have much less debt than equity, thus yielding a ratio well below 1. Many other measurements are helpful and some are particularly applicable to specific industries. Discussing Balance Sheet strength with your accountant will lead to ongoing examination of your business from a new vantage point.
The Finance Writer 