The Balance Sheet shows a snapshot of your company’s financial health on a particular date. Despite its importance, it sometimes fails to get the attention it deserves.
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What Can the Balance Sheet Tell Me About My Business?
The Balance Sheet tells you about the overall health of your business. A careful review of the Balance Sheet can tell you:
- What is the health of the business?
- Is it succeeding or failing?
- How is the business doing compared to other periods in the past?
- How does it compare to other companies in the same industry?
- Should this business be granted a loan? Is the business credit-worthy?
- What resources are available to the firm?
- How were they financed?
- Is it wise to invest in this company?
- What is the profitability of the company?
- Is there adequate liquidity to meet short-term obligations?
- Is the business solvent? Can it meet long-term commitments?
- Has the business complied with reporting requirements?
What Does a Balance Sheet Look Like?
What is the Accounting Equation?
The Accounting Equation is the basis of the Balance Sheet:
ASSETS = LIABILITIES + OWNER’S EQUITY
Sections of the Balance Sheet
ASSETS
Think of Assets as ‘things your business OWNS’. On the Balance Sheet, Assets are often divided into:
Current Assets (items that are likely to be converted into cash within one year)
- Cash
- Bank Accounts
- Accounts Receivable
Fixed Assets (items that are not likely to be converted into cash within one year.)
- Equipment
- Vehicles
- Building
- Land
LIABILITIES
Liabilities are ‘things your business OWES’. Liabilities are also divided into:
Current Liabilities (items that you are due within one year)
- Accounts Payable
- Credit Card debt
- Payroll liabilities
Long-term Liabilities (items that are due in more than one year)
- Car loan
- Mortgage
- SBA Loan
OWNER’S EQUITY
When you take all the Assets of the business and subtract the Liabilities, the amount that remains is what the OWNER can claim as their own. The names of the Equity accounts will vary depending on the ownership structure of the business. However, this category generally includes:
- Owner’s Equity
- Owner’s Contributions (How much has the owner contributed to the business)
- Owner’s Draws (How much has the owner withdrawn from the business)
- Net Income (Generally your profit before taxes)
- Retained Earnings (Accumulated profits that have not been withdrawn from the business)
- Owner’s Equity
BASIC ANALYSIS
There are three financial ratios that are used to analyze your balance sheet. These ratios help you see the health of your business, understand how your performance compares to other periods of time, and see if your business results are consistent with other businesses in your industry.
Current Ratio
- Measures your liquidity (how easily your current assets can be turned into cash.
- The higher the ratio, the greater the liquidity
- Your Current Ratio should stay above 2:1.
- To calculate:
- Current Ratio = Current Assets/Current Liabilities
Quick Ratio
- Measures your ability to cover your debts using easy-to-liquidate assets.
- The higher the ratio, the greater the liquidity
- Your Quick Ratio should stay above 1:1.
- To calculate:
- Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivable)/ Current Liabilities Assets/Current Liabilities
Debt to Equity Ratio
- Measures how much your business depends on equity versus borrowed money.
- Optimal Debt to Equity ratio varies by industry, but should not be above 2.0
- To calculate:
- Debt to Equity Ratio = Total Debt/Owner Equity