What You Always Wanted to Know About a Balance Sheet (but were afraid to ask)
You’ll need one if you want to get a small business loan. It also comes in handy if you’re calculating your tax deductions. And it helps you decide if it’s time to replace that old piece of equipment. What is this must-have business tool? It’s a balance sheet and it tells you how financially fit your business is at a point in time. Whether you draft your own balance sheet or work with an accountant, it’s important to understand its components and how they work together.
The Three Parts
The balance sheet looks at three things—your business’s assets, its liabilities, and your equity in the business. Accountants say it in the equation: Assets = Liabilities + Owner’s Equity. Notice how the two sides of the equation “balance” each other out? That’s where it gets its name.
Here’s how it’s broken out:
Assets – This is the stuff your business owns. It includes current and long-term assets. Current assets are the things you can sell for cash within a short time, usually one year. That includes cash or inventory. Long-term assets are items that cannot be converted into cash or consumed within a year. Property and equipment fall into this category.
Liabilities – This is what your business owes to others. They’re divided into current and long-term types. Current ones are those due within a year like obligations incurred for unpaid rent, supplies, or employee wages. Long-term liabilities might include that portion of a bank loan that is not payable within a year.
Equity – This is your right to the business’ assets in monetary terms.
Putting it together, the stuff you have (assets) is always equal to what you owe to others (liability) plus what’s yours (equity).
What It Means
The information in a balance sheet can be analyzed by comparing the different parts together. Your accountant can help you do that, but here are some of the comparisons used:
- Debt-to-Equity Ratio – This compares your total liabilities to your equity. It measures how well your company can meet its obligations and how much its growth is financed with debt.
- Current Ratio – This compares current assets to current liabilities. It is one measure of your business’s ability to convert assets into cash to pay its current liabilities.
Make sure your business adds up by taking advantage of the balance sheet. Working with your accountant, it can help you monitor the performance of your business. And that means you’ll make better decisions.