Opinions expressed by Contractor the contributors are theirs.
One of the tools that can be used to assess the performance of your business or organization is a balance sheet. A balance sheet, which should be part of your business plan’s financial model, categorizes your assets (everything you own), liabilities (everything you owe) and equity (the financial contributions made by all owners of the company). The cardinal rule for a balance sheet is that your total assets should equal the sum of your total liabilities and your equity (i.e., assets = liabilities + equity). If this equation isn’t true, then it’s because of an accounting error, not because your business is performing poorly.
Balance sheets can be difficult to understand because a change in your assets almost always implies a change in your liabilities or equity (or vice versa) so that the above equation holds true. Although it would take more than an article to explain all the intricacies involved in balancing a balance sheet, the following information will help you know what needs to be accounted for in your balance sheet and where.
Related: 3 Reasons Why You Can’t Trust Your Personal Balance Sheet
Current and long-term assets
Assets fall into one of two categories: current assets or long-term assets. Here are some common examples of current assets.
Your money is simply the money you have in the bank or perhaps some other place where it is readily available.
This does not apply to all businesses or organizations, but accounts receivable are money owed to your business that has not yet been received. Your car insurance company probably sends your bill about one to two months before it’s due. From the time the bill is issued to the time the bill is paid, the bill amount would be an example of an account receivable to the insurance company.
Your inventory is made up of items that are used as a direct result of fulfilling customer orders and need to be replenished to continue fulfilling orders. A good rule of thumb is that your inventory should be equal to the cost of goods sold in your income statement — except that in your income statement you factor in the amount of those goods used to generate the revenue you earned, whereas in the balance sheet, you factor in the total amount of those assets you have on hand.
The assets mentioned above are considered “current assets” because your supply comes and goes, so the value of each can fluctuate at any time. Many companies also have long-lived assets. Here are some examples of things that would go into long-lived assets, if any.
Furniture, fittings and equipment
Furniture, Fixtures, and Equipment (FFE) includes all tangible items that your business has purchased that help the business earn money, but are not used or replenished. Stoves and ovens would be good examples of equipment for a restaurant while chairs and desks would be good examples of furniture for an office.
This doesn’t apply as often, especially for small businesses, but intellectual property involves intangible assets that often serve as legal protection for your ideas. Patents, copyrights and trademarks are excellent examples of intellectual property.
Although not a cash expense, depreciation is factored into a balance sheet since long-lived assets depreciate over time. For intellectual property, amortization is the correct term since this property does not lose value on its own, but only provides protection for a specific period.
Related: Being in Business for More Than Just a Balance Sheet
Current and long-term debts
Like assets, liabilities are grouped into current and long-term. Here are some examples of current liabilities.
Accounts Payable includes all outstanding amounts that your business owes but has not yet paid. If you hire a professional cleaning company to clean your office in a given month and you have not yet paid your bill (but are still within the bill due date), the cost of the cleaning would be an example of an account payable. Accounts Payable also includes recurring bills that are paid in full on a monthly basis, but do not involve the repayment of an outstanding debt over a long period of time. Telephone bills and utility bills are good examples of accounts payable.
Current borrowings are not as common, but if you have a line of credit for your business, the cost of any purchases made in a given month would be considered current borrowing until you pay your credit card bill, assuming you pay it the following month. month.
The liabilities mentioned above are considered “current liabilities” because they are likely to be repaid and balanced in the short term. If it’s a recurring bill, it will probably be paid the following month.
Long-term liabilities are debts incurred by your business that are repaid over a long period of time. A bank loan used to fund your business is a great example of a long-term liability.
The following are examples of equity expressed in the balance sheet.
Paid-up capital takes into account any financial contribution made by the owners to the business. These contributions are most often paid at the start of the business, although cash injected into the business at a later date is also taken into account here after the fact. It should be noted that if an owner withdraws an amount of this money at some point, this amount will no longer be taken into account (the same amount will be taken from the money in your assets to balance).
Earnings are basically your net profit (or loss) for the period you are reporting. So if you if your balance sheet is for the year 2021, then your net profit for the whole of 2021 would be your revenue.
While your earnings take into account your net profit for the current reporting period, your retained earnings take into account your cumulative net profit or net loss from previous years. So, if you started your business in 2021, your retained earnings for 2021 will be $0 since retained earnings are based on the previous reporting period. However, your 2021 income (i.e. your net profit as explained in the previous point) would be what you show on your 2022 balance sheet for your retained earnings. Next, you’ll add your net profit for 2022 to your retained earnings for 2022 (or subtract your net loss) to determine your retained earnings for 2023.
Balance sheets can be complicated, but once you understand what they take into account and how to read them, they can be useful in assessing the health of your business.
Related: A Guide to the 3 Best Financial Reports for Small Businesses