By definition, your balance sheet measures your business’s net worth by taking into account assets, liabilities, and equity positions. It literally gives you a snapshot of your financial strength
Your balance sheet is part of a trifecta of accounting statements, which also includes your cash flow statement and income statement (P&L).
You have a business to run — helping empower you to do that is our job at ForwardAI Predict. Part of managing cash flow with professional acumen is to know what’s going on inside your books. Here’s what you need to know about your basic balance sheet for a small to medium-sized business:
Table of Contents
- 1 What is a balance sheet?
- 2 What your balance sheet tells you
- 3 Why you need a balance sheet
- 4 Where your balance sheet fits into the big picture
- 5 Getting a sense of your liquidity
What is a balance sheet?
A balance sheet is an accounting document (financial statement) that lets you get important information about your business’s financial position at any given time. (Usually, businesses produce one quarterly or yearly — but that time period is up to you.) Sometimes also called the statement of financial position, the balance sheet is based on a straightforward equation:
Assets = Liabilities + Equity
On any balance sheet example, you’ll usually see assets on the left with liabilities and equity on the right. Sometimes, in a vertical format, assets will be on the top of the balance sheet, with liabilities and equity on the bottom. Either way, it’s a pretty readable, accessible document.
As you’ve likely come to understand around anything related to accounting, there’s more to your balance sheet than a list of numbers.
This is the good stuff. Your assets include your tangible holdings, both liquid and illiquid. For example, think cash and equipment, respectively. Your inventory would be included here, too.
When listed on your balance sheet, you might subdivide these into things like fixed assets (real estate, machinery) and current assets (accounts receivable, petty cash). That’ll help you get a better picture of what you can access and quickly convert to funds should you need to.
You might also be wondering about things like patents, trademarks, or intellectual property (IP). Technically, IP and similar holdings are also considered assets — although these are classified as “intangible” assets, which are different. And, unsurprisingly, much harder to value. (Relatedly, many investors dispute the exact worth of intangible assets — and value them differently on an individual basis.) (Unless you hold the patent for a best-selling soft drink, velcro or breakthrough in quantum computing.)
Any debt lives here. If you’ve taken on business financing, for instance, that loan principal and its interest will live within your liabilities column. Business credit card balances, too, as well as outstanding invoices.
This also includes your operating expenses. Your overhead needs to be counted here: Think salaries and benefits, rent, and any taxes you’ll owe, too.
Like your assets, an organized business owner will find it advantageous to organize liabilities by type, too. A good way to consider them is as current (utilities, taxes) or long-term (mortgage, loan interest). This’ll also come in handy when you’re trying to see if your cash flow projections will cover you for both now and down the line. Plus, you’ll be able to figure out if you’ll have the liquidity to reinvest retained earnings (onto that next).
Equity (also known as shareholders’ equity) is the last piece. You’ll figure out whether you have any equity in your business when you subtract your liabilities from your assets. You can also think of this as net assets. As such, you’re going in the right direction if the number is positive — that means you have more assets than debts.
There’s one more step to get the full picture of your retained earnings. In other words, the money that’s actually left to reinvest into your company. If you have investors, you’ll have to distribute any remaining dividends. However, account for shareholder payments before you get your final equity number.
What your balance sheet tells you
Your company is like a living, breathing organism. Or, it certainly feels like that because everything is constantly changing. When things are moving so quickly, it sometimes seems impossible to freeze time on any given day and ask, “How are things really going?”
Your balance sheet is the closest tool to being able to do just that. A balance sheet is a financial snapshot of your business at a specific time. It’s like a photograph in the sense that it captures a moment. But, that also means that it’s not like a time-lapse video, which is why you’re not going to want to rely on it for any kind of historical or trend info.
Why you need a balance sheet
First of all, if you’re an S-corp or a C-corp, you need to provide one to the Internal Revenue Service (IRS). That’s just the law. But, think of this less as of why you’d need a balance sheet and more of why you’d be at a disadvantage without one.
To know how you’re doing relative to industry benchmarks.
How’s your financial position relative to others in your sector? Where’s your money going relative to others? Are you holding onto way more working capital, or do you not have enough cash? The answers to these questions will all be different depending on a company’s needs. But you should know where you fall relative to others. Especially if the info is out there.
If investors come knocking, they want to understand your distributions.
If you’re in the lucky position in which investors want to put money into your company, a balance sheet will be one of the absolute most important documents they’ll evaluate. Foremost, they’ll look where you’re allocating your capital, how much cash you have on hand, and even if you’re holding onto unnecessary working capital or other assets. Equally, they’ll be able to tell how you’ve managed your business based on the liabilities you’ve racked up.
To get the whole sense of your company’s finances.
Remember how we mentioned a balance sheet was like a photo, not a time-lapse? Well, in order to get to that long time-lapse, you need that singular photo.
Where your balance sheet fits into the big picture
Filling out an accounting balance sheet alone isn’t enough to manage your business to its fullest potential. Those assets and liabilities you documented on your balance sheet? Your Profit & Loss (income statement) shows where that money went, when you spent it, or the avenues through which it came in.
Your cash flow statement and balance sheet start work in lockstep. Your balance sheet shows your net cash, and your cash flow statement uses that number as the basis of its documentation for your cash position. Any time anything related to cash on your balance sheet changes, your cash flow statement changes too.
Cash flow statements and forecasts both pull information from your balance sheets and income statements. Establishing a regular practice of creating cash flow forecasts helps you create a historical record of your cash flow that can be used to track trends and make informed predictions. (Think snapshots turned into a time-lapse sequence.)
Getting a sense of your liquidity
If you feel like this all keeps coming back to cash, you’re not going crazy. Your balance sheet, working in conjunction with the income statement and cash flow statement, let you as a business owner ensure that you’re in the financial driver’s seat.
And a lot of that has to do with cash: Making sure you’re not spending too much cash in the present, that you have enough of it for later, and that it’s allocated in the right places for the future.
Part one of optimizing your business’s cash flow is having all three of these statements organized and up to date. The other is having insightful cash flow forecasting and risk assessment (included in your forecast) at your disposal in order to start seeing the patterns in your inflows and outflows.
ForwardAI Predict integrates directly into QuickBooks Online — and signing up is quick and easy. (No photography lessons required.) (Other integrations are on the way.)
The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.
Images via Pexels and Shutterstock.