Whether you’ve opened your own law firm or veterinary practice, or you’re making homemade artisan soap out of your kitchen, you love what you do. You may not, however, love managing your business finances. Even so, you’ll need to learn how to analyze financial statements.
Creating and understanding financial statements doesn’t have to be scary for a small business owner. In this piece, we’ll break down what a balance sheet is and why it is important to your business, how to read and understand a balance sheet, and how to use it to improve the financial viability of your business.
What is a Balance Sheet and What is its Purpose?
A balance sheet communicates an organization’s book value — or worth — at any moment in time through a look at the assets, liabilities, and shareholder equities. It can be used internally or externally to determine the health of a business. While a balance sheet is an important document, it is a reflection of the past. Comparing a series of balance sheets can be used to predict future performance, but it is not guaranteed.
Who Uses the Balance Sheet?
There are a variety of situations that call for the use of a balance sheet. This financial statement can be used so:
- Business owners can create a better strategy to move their organization forward.
- Employees can craft better processes that will enable them to achieve the goals of the organization.
- Potential investors use the balance sheet to determine if the organization is a good investment.
- External auditors will review this statement to ensure the organization is complying with industry or government regulations.
How to Access Your Balance Sheet.
If you’re handling your financial books by yourself, you can access balance sheets within your bookkeeping software. If you are working with a CPA or bookkeeper, they will prepare a balance sheet for you on a regular schedule, typically at the end of a period (monthly, quarterly, or annually). The frequency will depend on the type of business you run and your preferences. Some businesses (ie: those who move a great deal of money like banks or financial advisory groups) may receive a balance sheet every day or every week. Retail stores or websites may only need them quarterly or even annually based on their size and revenue. If you’re unsure how often you need to pull and analyze these financial statements, it’s better to err on the side of caution. You’re less likely to get too far off track with more touchpoints.
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How to Read a Balance Sheet.
Knowing how to read a balance sheet comes down to understanding where the numbers come from and how to analyze the information. This financial statement is broken up into three categories:
- Assets
- Liabilities
- Equity
We’ll go into more detail about these in a bit. For now, let’s look at an example. You are a chocolate fanatic and opened your own company making decorative chocolate for parties and special occasions. After three months in business, your balance sheet shows:
- Assets (your business bank account) with $2,000
- Liabilities (chocolate-making supplies for an upcoming wedding) of $400
- Equity (retained earnings) of $1,600
A thriving business should see an increase in equity as time goes on, while a struggling business will see a decrease. Keep in mind that if you see a temporary decrease, it might be due to money being invested back into the business.
Understanding the Balance Sheet Equation.
The Balance Sheet Equation is relatively simple. The most common equation used is:
Assets = Liabilities + Owners’ Equity
It can also be stated as:
Equity = Assets – Liabilities
This equation will help you understand how well the business is performing. However, you’ll need to look at Income Statements and Cash Flow Statements to get a more complete picture.
Understanding Assets in Small Business Accounting.
The first section of a balance sheet includes assets, also known as anything the company owns. This can include:
- Money
- Equipment like machinery used to manufacture products
- Furniture such as desks, the chairs in your waiting room, or exam tables
- Land and buildings, including stores, factories, office buildings, etc.
- Intangible property like government patents or copyrights.
Understanding Liabilities in Small Business Accounting
The second section of a balance sheet lists the organization’s liabilities or what is owed to other people. This can include:
- Credit card debt
- Mortgages
- Bank loans
- Money owed to vendors or suppliers
- Accrued expenses like employee wages, utilities, taxes, etc.
Understanding Equity in Small Business Accounting
The last section of the balance sheet is the Owners’ Equity or Shareholders’ Equity, which refers to whatever belongs to the owners of the business once the liabilities have been taken care of. This includes:
- Money that has been invested in the business in exchange for ownership or shares (like $5,000 startup funds to create a business and set it up online); and
- Earnings that the company creates over time.
Let Larry L. Bertsch, CPA & Associates Help with Your Small Business Finances and Financial Forecasting, Call Us Today!
Knowing how to read financial statements is essential no matter what size your business is. Whether you’re looking to streamline processes, expand your operations, bring on an investor, or prove that your reporting is up to par, regularly creating and analyzing balance sheets will help you reach your goals. You do need to do it… but you don’t have to go it alone. Larry L. Bertsch, CPA & Associates can provide the bookkeeping, accounting, and tax planning services you need for your specific business. Let us handle your books so you can get back to doing what you do best. Contact us today!
