In last week’s article on understanding your most important financial statements, we kicked off a series of articles to help you, the small business owner, confidently understand your basic financial statements. We used the illustration of learning to ride a bike to show that even though learning how to read your numbers can seem daunting, once you “get it” you’ll have a valuable skill to use for the rest of your life.
To take the bike theme a little further this time, imagine your first bike. It probably had training wheels, didn’t it? (I recently heard a kid refer to his as a “four wheeler” to make it sound cooler…two main wheels & two training wheels on the side.) That’s the financial reports “bike” we’re going to build over the next few articles. Each report will represent one of the wheels: Balance Sheet, Income Statement, and Cash Flow.
“Wait a minute,” you say. “I thought this bike had 4 wheels. That’s only 3! I thought you were supposed to be good with numbers!”
You are very observant, Daniel-san. And you have passed the first test. (I know I’m mixing my metaphors here, but..come on…there’s always room for Karate Kid! Wax on. Wax off.)
The 4th report we’ll introduce you to at the end of this series is one we’ve developed at Patrick Accounting exclusively for our clients. We call it the Scorecard, and we think you’re going to love it. More on that later. But now:
So today, we start with a look at our first report: The Balance Sheet
What is it?
Your balance sheet shows you the financial position of your business on any given day. It is typically generated at the end of a month, quarter, or year. The basic equation used is:
Assets = Liabilities + Equity.
It let’s you and other interested parties see exactly what your business has as well as what it owes at that particular point in time. It’s a great tool to help you evaluate the overall health of your business. Potential creditors, investors, and even some customers may find it useful when they are considering whether or not to attach their hard-earned money to your company.
3 Things You Should Understand About Your Balance Sheet
To fully understand your Balance Sheet, it’s as easy as knowing what makes up the 3 parts of the equation above. So let’s dive in!
These are things your business owns that have future value. If you can sell it or trade it at some point to get something else you want…it’s an asset. (Unfortunately, your winning smile and killer charm–though they may be assets socially–don’t qualify here.)Examples of common assets your business probably has:
- Cash (Your bank accounts)
- Accounts Receivables (money owed to you from your customers)
Anything you owe someone else is a liability. (The slacker nephew you never should have hired may also be considered a different kind of liability, but there’s just not a way to write that on your Balance Sheet.) You can think of liabilities as the part of your company’s total assets that someone else can claim instead of you.
- Accounts Payable
- Payroll Taxes collected from your employees but not paid to the government yet
- Total Loan Amounts due
- Customer Deposits (for work not yet completed)
This is the good stuff! Equity is the part of your total assets that you get to keep (for a while anyway). Lots of factors can make this number go up or down. Revenue you hold on to increases your equity while withdrawals (money taken out for personal use) and expenses decrease it.Equity is generally made up of:
- Money invested in the business
- Retained Earnings (Profits of the business not taken out yet)
- Current net profit (your revenue less your expenses, there’s more about this in the upcoming article on Income Statements)
Note: Equity only shows you the book value of your business. It does not reflect its market value. Since things you purchased either appreciate or depreciate over time, what someone would pay to buy your business (market value) can be vastly different from the numbers that show up here on your Balance Sheet.
If you’re interested in learning even more about Balance Sheets, take a look at this helpful video from Kahn Academy.
It may seem like a lot, but hang in there, grasshopper. Like Mr. Miyagi said, “Man who catch fly with chopstick, accomplish anything.”
In our next post we’ll dive into the Income Statement.