From financial wellness to financial intelligence, your bookkeeper and controller can help you gain insight about your business through your balance sheet.
Of all the key financial statements that business owners must understand, including the income statement and cash flow statement, the most important is the balance sheet. It shows the company's true financial position in a way no other document does.
What Is a Balance Sheet?
Anybody who has taken an accounting class knows the formula that the balance sheet is based on: assets = liabilities + owner's equity.
Seems straightforward enough. The key is to make sure you're accounting for each of those categories in its entirety. And the first step is to define the terms:
- Assets: company-owned resources or things of value
- Liabilities: an entity's financial obligations
- Owner's equity (a.k.a. net assets): the owner's or shareholders' cumulative equity, including distributions to shareholders
Both assets and liabilities are divided into short-term and long-term (or "non-current"). Liquid accounts including cash, inventory and accounts payable are short-term. Fixed assets, property, plant, equipment and debit obligations over one-year are non-current.
Simply put, when assets are greater than liabilities, the balance sheet shows positive net worth. When assets are less than liabilities, the balance sheet shows negative net worth.
Why Is the Balance Sheet So Important?
For starters, the balance sheet lets you know at a glance whether your company is currently operating in the red or in the black.
Beyond that, it's critical because it provides signposts that business owners, CFOs and advisors can use to make informed decisions. Some business owners don't pay enough attention to these signposts until it's too late.
While other financial statements show only a view of transactions that have already occurred, the balance sheet gives you a bigger picture. Let's say you just made a large sale. If all you look at is the income statement, you might conclude the company is doing well. But it doesn't tell the other side of the story, such as whether a large vendor invoice is due. The balance sheet does.
How Can You Make the Best Use of Your Balance Sheet?
Besides providing an instant "financial wellness" check, the balance sheet contains intelligence that you can use to grow your business. Investors and banking officers rely on balance sheets to guide their decisions. Managers use the financial data in balance sheets to help them measure profitability and the rate of return on investments.
Analyzing Your Balance Sheet
You can learn a number of things about the financial status of your business from analyzing your balance sheet, including:
- Profit growth rate is used to calculate your company's profit growth by comparing accumulated profits year by year.
- Return on equity shows how much money your capital and other equity investments generate for your business. Determine it by dividing the equity account(s) by the company's net revenues (as shown on the income statement).
- Return on assets shows how much money your company's assets generate, taking into consideration the investments made in acquiring them. Determine it by dividing net income by total assets.
- Debt ratio indicates the percentage of assets to short-term liabilities. Take the sum of your short-term liabilities and divide it by your total assets. Multiply the result by 100 to convert to a percentage. The lower the ratio, the better. (High ratios indicate high debt and may decrease the chance of obtaining a loan. They could even be a harbinger of bankruptcy.)
- Current ratio, which is similar to the debt ratio, looks at current assets divided by current liabilities. This shows how liquid your business is.
There's a Lot Hanging in the Balance
We've really just scratched the surface of all the different types of financial analysis you can use to drive solid decisions based on your balance sheet. As a business owner, you probably don't have the time (or the inclination) to perform that financial analysis yourself. That's why it's so important to line up top-caliber bookkeeping and controller services, along with a network of CPAs, bankers, attorneys and other specialists.
Without an accurate, up-to-date balance sheet, you won't know where your business is today — and where it's headed tomorrow.
At Supporting Strategies, our experienced, U.S.-based professionals use secure, best-of-breed technology and a proven process to provide a full suite of bookkeeping and controller services. Are you ready to learn how you can move your business forward? Contact Supporting Strategies today.