How to Read one
How to Prepare One
The Balance Sheet is one of the 3 basic Financial Statements. These are the Balance Sheet, the Income Statement, and the Statement of Cash Flow. It is an important tool to help you manage and run your small business.
The Balance Sheet is prepared as of a certain date, for example, as of December 31, 2017, and tells you what your business owns, what it owes, and what it is worth, as of that date in time.
There are 3 basic pieces or sections of a Balance Sheet:
1) What your business owns – these are your Assets.
2) What your business owes – these are your Liabilities.
3) What your business is worth – this is your Equity. Also called Net Worth or Capital.
Assets are always listed first, then Liabilities and Equity, and they are listed together.
As you can see from the sample above, the Assets are listed first, and totaled (Total Assets).
Then the Liabilities are listed and totaled (Total Liabilities).
Then the Equity is listed, totaled (Total Equity).
The Liabilities and Equity are added together (Total Liablities and Equity), and that should equal your Total Assets.
OK, but what is included in each of these sections, right?
Assets are things your business owns, like cash, receivables, buildings, and vehicles.
There are 3 different types of Assets:
1) Current Assets – cash or things that can be quickly converted into cash, like receivables, cd’s or money market accounts, inventory, etc.
2) Plant & Equipment – buildings, equipment, vehicles, these are longer in life than Current Assets, and are depreciated.
3) Intangible Assets – these are more subjective things, like Goodwill or a Customer List, that are mainly used when you purchase a business. For example, you purchase a business for $100,000, when the assets purchased equal $80,000, but you paid more for it because it’s a popular restaurant, for example. The $20,000 extra you paid is for “goodwill”.
Liabilities are things you owe – payroll taxes, loans, etc.
And there are 2 types:
1)Current Liabilities – things you need to pay within a year, like payroll taxes, short-term loans or lines of credit.
2)Long-term Liabilities – things you will be paying on more than a year, like a vehicle loan, or building loan, etc.
Equity is a quick way to see how much your business is worth, but there are many factors, so don’t panic if your Equity is kind of small.
Equity is the most confusing of the 3 parts of a Balance Sheet, but only because it changes with the type of business, be it a sole proprietorship, a partnership, or a corporation.
For a sole proprietorship, Equity will consist of:
For a partnership, Equity will consist of:
Owner 1 Capital
Owner 2 Capital
For a corporation, Equity will consist of:
Now you know the basic sections of a Balance Sheet. But how do you read one?
Reading a Balance Sheet is quite simple.
Take a quick look at the Assets.
What kind of Assets does this company own? How much cash do they have? Are they carrying a lot of Inventory? Do they have a lot of Receivables? Maybe they’re not too good at collecting? Do they have Equipment or Buildings? In the sample here, you can see this company has quite a bit of cash, and has more Current Assets than Plant & Equipment, and no Intangibles. That may be good or bad, depending on the industry.
Next, take a quick look at the Liabilities.
What’s the amount of Total Liabilities compared to Total Assets? Do they have a large debt load? In the sample, you’ll see an amount labeled “Accrued Expenses” – this means they have expenses due in the future that they have already incurred, the best example of this is payroll taxes due at the end of the quarter.
Also notice that Total Current Liabilities is less than Total Current Assets. This is good, and it is called the Current Ratio. What it means is that if you had to, you could convert your Current Assets to cash, and pay off your Current Liabilities.
Take a look at Equity.
The sample shows us a corporation, so the Equity section consists of Common Stock, and 2 other items we haven’t covered. Additional Paid-in Capital is used when someone pays more than stated value for their Stock. Retained Earnings simply is an accumulation of net incomes (profit) or losses for the years this small business has been in operation. A positive number tells you this business has had more profit than loss.
If you want to know more about a company, yours included, take a look at two or three years of Balance Sheets. Compare year to year. Is cash increasing or decreasing? What about Inventories and Receivables? If they are increasing due to increased Sales, that’s to be expected. Are liabilities increasing or decreasing? If Equity is increasing, the business should be making profits. But it could also mean the owner is putting money into the business. You can learn a lot by comparing a couple years of Balance Sheets.