At AIS Solutions, part of what we always are trying to do is help business owners understand their financial statements. I’ve always felt very strongly about how fundamental sound financials are for running a business, as they don’t only help you to understand the past, but predict and plan for the future.
I often sit down with our business owner clients to walk them through their business financials, and there are many questions that arise with great frequency. I’ve decided to write a series of articles on just these topics – and go back to the basics of reading and understanding your financial statements.
I’ll start with what statements a typical business owner should be reviewing on a regular basis. Regardless of what industry you are in, at a minimum you should be looking at your Balance Sheet and your Income Statement. This article is going to focus on the basics of the balance sheet.
What is a Balance Sheet?– A balance sheet is probably the most unread financial statement for business owners. It generally is also the one that most bookkeepers who don’t have enough experience, tend to bury things, when they don’t know what to do with a transaction.
Here is a sample of what a balance sheet looks like for a relatively simple retail company. The larger and more complex your business, the more lines that are likely to be found on this statement.
At its very core, the balance sheet offers you a snapshot of the true health of your business. It is the financial statement examined by investors if you want others to put money into your business, and it is also what any lender will want before they lend you a dime.
There are 3 main sections to a Balance sheet – Assets, Liabilities and Equity.
What are Assets? This is first section of your balance sheet and represents the value of what your company owns. Things that would be included in the asset section could be :
- Balances in your bank accounts,
- Accounts receivables, – or money that you have to collect from your customers.,
- Inventory that you have purchased, but not yet sold
- Investments that you’ve purchased
- Any equipment, furniture, vehicles, etc. that you own.
In this section, everything will be included that you own, regardless of how long it would take you to convert it to cash or sell it.
The second section is called the Liabilities section.
What are Liabilities?
With the asset section representing what you own, the liabilities section represents the value of what your company owes. Similarily to assets, the liability section is made up a multitude of different types and sources. Some examples of liabilities would be:
- Money owed to suppliers for the purchase of product/service
- Loans outstanding, whether from lending institutions, investors or yourself as a shareholder
- Corporate Income Taxes owing to the government
- GST/HST owing
- Credit Card Balances owing
- Money owed to Employees for vacation that they have earned, but not yet taken
Again, everything that your company owes or more conservatively, may owe, is listed here, regardless of how long it will take you to repay it, or if you have the ability to repay it.
The last and final section of the Balance Sheet is called the Equity Section, or Shareholder’s Equity.
As the name implies, the balance sheet must balance, whereby the Assets of your Business must equal the Liabilities and Equity of your business. Therefore, in its simplicity, the difference between the Assets and the Liabilities is the equity.
Equity = Total Assets – Total Liabilities
The equity can be defined as what you as the shareholder own. If your liabilities, or what you owe, are higher than your assets, or what you own, then you may have negative equity in your company.
Make sense? Hopefully my explanation gives you a basic understanding of what the balance sheet represents. Future posts will go into detail about the different line items in each section, but before we delve into the nitty gritty, we need to have a handle on the big picture.
If there are any specific questions that you have relating to your balance sheet or even your financials in general, please let me know, as I’d love to cover it in a future post.
Check out Accounting and Bookkeeping Basics – Part 2 – Current Assets