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How To Understand A Balance Sheet For Small Businesses
Balance sheets are a critical component of your small business’s financial records. While it’s not a lengthy document, a balance sheet is still a top way to gain insight into your company’s monetary advantages and disadvantages. Plus, it can give you and your virtual financial advisor a feel for where your business’s finances are heading.
Unfortunately, looking at a balance sheet without prior experience can feel like reading hieroglyphics. The numbers and financial jargon columns can cause a headache for any business owner! That’s why we’re here to break balance sheets down section by section. Learn how to understand a balance sheet within minutes by reading below.
What is a business balance sheet?
A business balance sheet is a report of a business’s assets, liabilities, and shareholders’ equity designed to calculate the value of a company. Generally, financial advisors recommend that small businesses obtain a balance sheet every month or quarter. That way, it can effectively see patterns in growth and detect any weaknesses in the business’s finances. The primary purpose of a balance sheet is to get a snapshot of a business’s financial position within a specific time frame.
If scanning over a balance sheet makes you sweat, there’s an easier way to approach it. While it might seem like an extensive process, the balance sheet can be simplified down to one short equation: Total Assets = Total Liabilities + Total Equity. An accurate balance sheet will always balance– that is, it will always follow this equation.
What are the necessary elements of a balance sheet?
The three key elements of a balance sheet are assets, liabilities, and shareholders’ equity. The report balances these elements to provide a comprehensive picture of the business’s financial state.
- Assets. A small business’s assets are everything it owns after liabilities are factored into the equation. Assets can have either current or future value, but all assets are or can eventually be turned into liquid cash. These assets can include accounts receivable, vehicles, and other property.
- Liabilities. A small business’s liabilities are what it owes to external individuals or corporations. Liabilities can include loan payments, taxes, and accounts payable. As opposed to assets, liabilities count against what a business owns. The goal should always have liabilities equal to or lower than its assets, so the company avoids debt.
- Shareholder’s Equity. The equity of a small business is what the owners and shareholders of a corporation own before the liabilities are subtracted. Typically, the equity includes retained earnings and investment returns. Ultimately, equity is the total value of the company. So, if all the assets of a business were liquidated and all debts were paid, the equity would be the remaining value.
How to read a balance sheet for small businesses.
When you examine a balance sheet, you’ll notice that it breaks the three key elements into smaller factors that make up the business’s entire account. By identifying these factors and examining them, you’ll easily be able to read a balance sheet and understand the business’s current financial state.
- First, it divides assets into two categories: current and non-current. Current assets are short-term assets that can be turned into cash within a year. Current assets are helpful because they can quickly result in significant returns, giving the company a speedy financial boost. Alternatively, non-current assets are long-term and will likely be cash within several years. Examples of current assets include accounts receivable, while non-current assets include long-term investments.
- Afterward, the balance sheet will list the business’s liabilities. All the recorded liabilities are money owed to outside individuals or companies, so it doesn’t count toward the business’s possessions. Balance sheets also split liabilities into two categories: current and non-current. With a similar timeframe to assets, current liabilities are payments owed within a year, while non-current liabilities are due in over a year. While liabilities like business loans can be used for growth, they should always ensure they have less liabilities than assets.
- Then, the balance sheet will record the owner’s equity. Generally, equity is split into two categories: share capital and retained earnings. Share capital is how much money shareholders have invested in the business. Retained earnings are the business’s net profit after dividends have been factored in. If the equity is positive, then the company is in good standing. However, if equity is negative, the business should be concerned with its ability to pay off its liabilities and avoid bankruptcy.
Over time and many balance sheets, you and your financial advisor will see valuable patterns popping up. As you learn to read your balance sheets, it’s integral to ask questions about growth patterns, the weight of your liabilities, and the overall development of your company.
What is the biggest takeaway from a balance sheet?
The primary thing that small business owners can take away from their balance sheet is a glance into their company’s finances in a snapshot in time. Reading a balance sheet can help owners determine if they have the resources to maintain or grow the business’s size or whether they should refinance and restrategize.
Balance sheets for small businesses are a top way owners determine their course of action for the next quarter or year. Understanding how to read a balance sheet is essential in making critical financial decisions like taking on new employees, receiving a loan, or buying real estate.
Balance sheets are also a vital tool for small business financial advisors. Financial advisors can make informed recommendations regarding your company’s next steps by creating and analyzing your balance sheet. Overall, balance sheets are a tool that every small business should take advantage of frequently.
Take control of your small business finances today.
Keep balance sheets from getting the best of you. Virtual Financial Officer is here to help you reach your financial goals and feel confident in your fiscal decisions. If you’re looking for someone to whip up your balance sheets, our virtual financial advisors are here to help. Contact us at support@vfo.co to receive a FREE consultation on our start-up and small business financial advising services.