Why your balance sheet is important
Your balance sheet is one of two major financial statements your business will produce (the other is your profit and loss statement, or P&L). Many business owners find the balance sheet hard to understand and interpret – but once you get the basics, it can give you valuable information about your business and help you manage it better.
Balance sheets are also used by potential lenders and investors to help them decide whether to support your business, so it pays to be familiar with them.
Your balance sheet is closely related to your P&L, so we recommend reading our article about understanding your profit and loss statement along with this guide.
A snapshot of the health of your business
In simple terms, a balance sheet is made up of three components:
- What the business owns — its assets.
- What the business owes — its liabilities.
- The overall value of the business — its assets minus its liabilities. This is known as the owner’s equity (it’s also sometimes referred to as the ‘book value’ of a business).
The purpose of the balance sheet, as its name suggests, is to balance these. That’s why the bottom line figures on a balance sheet must always match each other. This is known as ‘the accounting equation’:
Assets = Liabilities + Owner’s equity
The simple example below illustrates this.
Assets
Current Assets
Cash: $15,000
Accounts receivable: $20,000
Inventory: $30,000
Total Current Assets: $65,000
Fixed Assets
Equipment: $100,000
Total Fixed Assets: $100,000
Total assets: $165,000
Liabilities
Current Liabilities
Accounts payable: $9,000
Bank overdraft: $11,000
Total current liabilities: $20,000
Long-term liabilities
Loan payable: $25,000
Total long-term liabilities: $25,000
Owner's equity: $120,000
Liabilities + owner's equity: $165,000
Understanding assets and liabilities
While some accountants or accounting packages may use slightly different terms, you’re likely to see the words ‘assets’ and ‘liabilities’ on your balance sheet. Here’s a simple explanation of what they mean.
About assets
Assets can be ‘current’ or ‘fixed’. Some of the assets you create can’t be easily counted, such as your brand, reputation, and any trademarks. While important, these aren’t included on your balance sheet.
Current assets
These are things you own that last less than 12 months and that you can convert into cash fairly quickly. Current assets include cash, inventory or stock (the things you have for sale), and the money owed by customers (accounts receivable). Money in your business bank account is another current asset.
Fixed assets
Sometimes known as ‘non-current’ assets, these are things you own that will last longer than 12 months. Examples include equipment, buildings, vehicles, and machinery.
About liabilities
Liabilities can be ‘current’ or ‘long-term’.
Current liabilities
These are amounts you owe that you will have to repay within 12 months. Outstanding invoices (accounts payable) and taxes are examples of current liabilities.
Long-term liabilities
These are amounts you owe that you pay over a longer period. They include things like loans, business mortgage payments, and lease payments for equipment or vehicles.
Using your balance sheet
Balance sheets aren’t admin for admin’s sake. Your balance sheet can help you understand the health of your business. For example, you can compare your latest balance sheet with earlier ones to check whether your business is getting stronger or weaker.
In particular, you can use the information in your balance sheet to calculate key ratios that you can compare against industry benchmarks or past performance to identify and fix potential issues in your business. For example, checking key ratios can help you answer questions like:
- Are you making enough margin?
- Is your stock turning over fast enough?
- How efficient is your business?
- Do you have enough cash to pay your bills when they come due?
To learn more about how to use the information in your balance sheet to manage your business better, read our guide about checking the health of your business.
The difference between your balance sheet and your P&L
Your balance sheet is a snapshot of your business and its overall health at a particular point in time. It contains information you can use to measure many different aspects of your business.
Your profit and loss statement (P&L) measures your profitability over a certain period (e.g. a month or a year). It helps you to identify trends that can impact your profit.
Frequency
Your accountant would typically produce a balance sheet once a year, but accounting packages now allow you to produce one any time you like. This can help you keep a close eye on how your business is performing, and identify and fix issues quickly when they develop.
So, next time you receive or produce a balance sheet, don’t put it in a drawer and forget about it. Taking the time to understand and review it, can help you build a better, stronger business – and a healthier bottom line.
How to prepare your financial statements
Learn about the two main financial statements for your business: the Balance Sheet and the Profit and Loss Statement, and how to calculate some key finance ratios like profitability, business efficiency, or business liquidity ratios.
Contact an ANZ Business Specialist
Our specialists understand your kind of business and the challenges you face as a business owner. We can help you figure out how to make your business grow and succeed.
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