Most entrepreneurs have heard of a Balance Sheet. In this short post, I am going to share a few things you should know about this financial statement and how it can help you as a business owner.
The Balance Sheet shows a company's assets, liabilities and owner/shareholder equity. I mentioned in my previous post Six Things You Should Know About Your Profit & Loss Statement (aka Income Statement), that the P&L statement includes your revenue (income) and your expenses. The Balance Sheet also has important information to share that many business owners may overlook. Included are the company's assets, liabilities and equity for owners or shareholders. Let's dive into these a little deeper.
What Is An Asset In Accounting? An asset is a resource with economic value that a company (corporation, individual, or economic entity) owns or controls with the expectation that it will provide a future benefit. That is the short definition.
The formal (aka long) definition would hurt your head, because it "hurts" mine (pun intended). However, I will add that assets often need to be split into two major classes (or groups), tangible or intangible.
A Tangible Asset if an asset that has a finite monetary value and usually a physical form (think building, bank account, office furniture, etc.)
An Intangible Asset is an asset that lacks physical substance (patents, copyright, franchises, goodwill, etc.)
What Is A Liability In Accounting? A liability is something a company (or individual) owes, usually a sum of money to another company, person or entity, and will be settled over time through the transfer of economic benefits including money, goods, or services (think bank loans, mortgages, unpaid bill, IOU's, etc.)
Again, there are often two categories of liabilities:
Short-term liabilities - a liability that can be paid back during a time frame of 1 year or less (accrued expenses, taxes payable, dividends payable, general accounts payable, payroll payable)
Long-term liabilities - a liability that will take longer than 1 year (12 months) to be paid off (pension liabilities, deferred income taxes, deferred compensation)
Still with me so far? Good, because there is a little more to the Balance Sheet...
What Is Owner or Shareholder Equity?
Owners' Equity is the total assets of an entity, minus its total liabilities. This number represents the capital (theoretically) available for distribution to the owner of a sole proprietorship.
Shareholder Equity (SE) is for corporations. This can also be referred to as stockholder's equity. It is the corporation's owners' residual claim on assets after debts have been paid. Shareholder equity is equal to a firm's total assets minus it's total liabilities.
So now you know what the categories on the Balance Sheet are called and what they represent, you might be wondering how this information can help you as a business owner...and that is a valid question!
In my humble opinion, a business owner cannot make sound, financial decisions on their business without knowing how much capital they own and what cash they owe. The last thing any business owner wants to do is get so far into debt, that they cannot get the business out. However, there are times a business needs to borrow money to continue and that is where knowing the financial health of your business comes in.
The Balance Sheet, along with the Profit and Loss and sometimes the Cash Flow Sheet are what banks, lending institutions, investors, stock holders and many other institutions look at to asses the financial health of a business. This is where good, sound bookkeeping comes in. Whenever necessary, you want to produce a clear and concise set of Financial Statements to show your business strength and financial health.
If you have any further questions about this or other bookkeeping subjects, please contact me at Rebecca@RHBizSolutions.com. I look forward to talking to you about your bookkeeping needs.
Here's To Your Success!
RH Business Solutions
Any accounting, business or tax advice contained in these articles, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please seek consultation from the appropriate accounting/tax professional.