Starting a Small Business

What Small Business Owners Need to Know About Balance Sheets

What Small Business Owners Need to Know About Balance Sheets

There are many valuable tools available to a small business owner, but one of the most valuable is the balance sheet. Balance sheets can provide such an accurate and immediate snapshot of a company’s financial status that some companies refresh them on a monthly basis. A balance sheet alerts a business’ owner to the most current data on their business’ financial status by clearly identifying all assets, liabilities and equity 

The balance sheet gets its name because assets are balanced by liabilities plus equity. To truly understand where a business stands financially and head off being caught off guard by economic surprises, it is necessary to update a balance sheet at least quarterly.

Let’s break down the individual portions of the balance sheet.

Assets

Assets represent the “plus” side of a business’ financials. The items and figures included on the asset side represent all that a business owns. Assets can be fixed or liquid. Fixed assets are things such as buildings, equipment, land and vehicles: items that are solid and can be sold, but not quickly or easily. They can depreciate in value.

By contrast, liquid assets (also known as current assets) are immediately available. They include money market accounts and investments, monies that are owed to the business (in Accounts Receivable and other sources), cash on hand, inventory, and any insurance premiums or other expenses that have been paid in advance.

Additionally, there are intangibles that are reported in the assets column of a balance sheet. These include patents and copyrights and goodwill. When assembling a balance sheet, it is important to note that the Accounts Receivable line item should be decreased by debts that the business owner anticipates will not be paid. These should be identified as a Reserve for Bad Debts.

Liabilities

Liabilities are recorded on the opposite side of a balance sheet from assets. The items and figures included on the liabilities side represent debts. These debts can be either long term or current. Long term debts would be those that are expected to be paid over an extended period of a year or more and can include things like long term loans, benefits owed to employees in the future, mortgages and leases and deferred taxes. Liabilities that are considered current would include short term loans or lines of credit, Accounts Payables, and taxes (sales, payroll and income).

Equity

Equity represents items such as capital stock, net income that has not been distributed to shareholders and owners, and capital or additional payment from investors that exceed the business’ stock’s par value. It is recorded on the same side of the balance sheet as are liabilities, and if a balance sheet is prepared correctly then the total of all of the assets can be subtracted from the total of all of the liabilities and will equal the equity amount.

How and Why a Balance Sheet Works

Preparing a balance sheet is not an intuitive act. It can be difficult to understand its structure, and for those who need assistance, this page may prove valuable. Once you have assembled the balance sheet and checked to make sure that you’ve done it correctly by doing the math as described above, you still need to be able to understand exactly what it is telling you in order for it to be of value.

Where it is most important is in allowing you to see problems developing. Items such as growing Accounts Receivables, shortage of cash reserves, or inventory outpacing revenue can be indicative of a trend that needs to be addressed quickly.

When you’re not familiar with tools like balance sheets, cash flow statements and income statements, they may seem like they’re written in a foreign language and of little value, but they can actually provide you with essential information.

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Frank Jenkins Jr

Frank Jenkins Jr

Frank Jenkins Jr. is the managing partner of Adams, Jenkins & Cheatham, a CPA practice based in Midlothian, VA. Frank specializes in Consulting services, tax planning, accounting, audit & assurances. "I genuinely care about our clients because I have a personal connection with them. This job requires me to multi-task and work under tight deadlines. I get great professional satisfaction from balancing firm and client commitments while building a strong team here at AJC."

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