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Balance Sheet

In order to make smart business decisions, entrepreneurs need to be well-versed in financial concepts like the balance sheet. The balance sheet is one of the most important financial statements, and you must know how to read it if you want to be successful in business. So what exactly is a balance sheet, and what information can you glean from it?

Keep reading to find out!

What is a balance sheet?

Let’s start with the basics. A balance sheet is a financial statement that provides a snapshot of a company’s assets, liabilities, and equity at a given point in time. The balance sheet is one of the three most important financial statements, as it provides valuable insights into a company’s financial health. It is sometimes called the “statement of financial position.”

There are many ways to format a balance sheet and different tools that you can use to create one, but the most important thing to remember is that the balance sheet must always balance. The total value of a company’s assets must equal the sum of its liabilities and equity.

If this still sounds like gibberish to you, don’t worry. We’ll go over what each term means and how to integrate it into your balance sheet.

What are assets?

Assets are items of value that a company owns. These include cash, investments, inventory, accounts receivable, property, equipment, and vehicles. Basically, anything that a company owns and could potentially use to generate revenue can be classified as an asset.

Assets are essential because they represent the resources that a company can use to grow its business. A company with strong assets is in a much better position to succeed than a company with weak assets.

What is the difference between current assets and long-term assets?

There are two main types of assets: current assets and long-term assets.

If a company needs to generate cash quickly, it can do so by selling its current assets. Current assets are assets that can be converted into cash within one year. These include items like cash and inventory.

Conversely, long-term assets are usually not converted into cash within one year. These include items like property, equipment, and vehicles.

The distinction between current and noncurrent assets can give insights into a company’s short-term and long-term liquidity. Current assets are more liquid than non-current assets, so you can convert them into cash more quickly. This is important to keep in mind if a company is facing financial difficulties and needs to generate cash quickly.

Special Case: Accounts receivable

Another crucial part of understanding assets is understanding accounts receivable. Accounts receivable (A/R) refers to the money that a company is owed by its customers. This can include things like unpaid invoices or services that have been rendered but not yet billed.

For example, let’s say that you run a digital marketing agency. These types of jobs usually involve a lot of work upfront, with the invoices being sent out after the work is completed. In this case, your accounts receivable would include any outstanding invoices your clients have not yet paid.

Accounts receivable can be a great source of short-term funding for a company. This is because businesses can often receive payment for their services before paying their own bills. This gives them a bit of a float, which can be helpful in times of financial difficulty.

However, accounts receivable can also be a source of financial stress for a company. There is always the risk that customers will not pay their invoices on time. If this happens, the company will be stuck with their regular bills and will have to find another way to pay it. That’s why it’s essential for companies to keep a close eye on their accounts receivable and to make sure that they are not extended too far.

The formula for accounts receivable is:

(Accounts Receivable / Revenue) * Number of Days in the Period

Different industries will have other accounts receivable turnover ratios. For example, companies that provide services will often have higher ratios because they are billing their customers after the work is completed. On the other hand, companies that sell physical goods will usually have lower ratios because their customers typically pay for the goods before they receive them.

What are liabilities?

Liabilities are the money that a company owes to its creditors. This can include things like loans, bonds, and interest payments. Loans are amounts of money that a company has borrowed from banks or other financial institutions. They will usually have to pay interest on these loans.

Bonds are like loans, but governments or large companies usually issue them. They are typically used to raise money for long-term projects. Interest is generally paid on bonds as well.

Liabilities are vital because they represent the money that a company owes. If a company cannot pay its liabilities, it will likely go bankrupt. It’s essential for companies to keep a close eye on their liabilities and to make sure that they are not extended too far. You could have all the income in the world, but if your outgoings are greater, you’ll have nothing left.

What is the difference between current liabilities and long-term liabilities

Once again, there are both current and long-term liabilities. Current liabilities are debts a company expects to pay off within the next year. These can include things like short-term loans and interest payments. Long-term liabilities are debts a company expects to pay off over a longer period. These include bonds, mortgages, and long-term loans.

Keeping track of both types of liabilities is essential because they can greatly impact a company’s cash flow. Current liabilities need to be paid off relatively quickly, so they can put a strain on a company’s cash reserves. Long-term liabilities, however, should be paid off over a longer time. They can be easier to manage, but it’s important to ensure that the payments are being made on time.

Special case: accounts payable

It’s also essential to keep a close eye on accounts payable. This is the money that a company owes to its suppliers. Manage this carefully because it can have a big impact on cash flow.

Most suppliers will give you a certain amount of time to pay your bill. This is called the payment terms. For example, a supplier might give you 30 days to pay your bill. You have 30 days from the invoice date to pay the bill. You will usually be charged a late fee if you don’t pay your account within the payment terms. This is an additional charge that is added to your bill.

The formula for accounts payable is:

(Accounts Payable / Expenses) * Number of Days in the Period

What is working capital?

Working capital is the money that a company has available to pay its short-term liabilities. Remember that not all your assets can be used to pay your liabilities. Some of them are tied up in long-term projects or investments.

As a result, companies need to have a certain amount of money available to pay their short-term liabilities. This is what we call working capital. It is often the toughest part of your cash flow to manage because you need to have enough money available to pay your short-term liabilities, but you also need to reinvest in your business to grow.

One way to think of working capital is the difference between accounts receivable and accounts payable. If you accounts receivable days is 60 and your accounts payable days is 20 you need 40 “days” of working capital. This is a simplification, but it works spectacularly.   

What is shareholder equity?

Finally, we have shareholder equity, which is the money that belongs to the shareholders of a company. It’s important to keep track of this because it represents the amount of money left if the company was liquidated.

Shareholder equity isn’t always easy to calculate because it can be affected by things like share repurchases and dividend payments. You’ll want to consider shareholder equity because it isn’t money you can use freely. It belongs to the shareholders, and you need to be able to pay them back if you want to keep your business going.

The balancing of the balance sheet

So, how do all these concepts tie together? As the name implies, a balance sheet aims to balance two sides: On one side, you have your assets, and on the other side, you have your liabilities and shareholder equity.

This equation is always true:

Assets = Liabilities + Shareholder Equity

When looking at a balance sheet, you want to ensure that the equation balances. If it doesn’t, then there’s something wrong. To balance the equation, you can either increase your assets, decrease your liabilities, or adjust your shareholder equity.

Remember that a balance sheet is a snapshot in time. That means that the equation might not always balance perfectly. For example, if you just made a big sale, your assets will go up, but your liabilities might not change immediately. It can create a temporary imbalance in your balance sheet. As long as you’re aware of this, you can manage it and make sure that your business is healthy.

Conclusion

A balance sheet is an important financial document that every business owner should understand. It’s a moment in time representing your company’s financial health and can give you a good idea of how your business is doing.

Remember to keep an eye on your assets, liabilities, and shareholder equity. Make sure your balance sheet is balanced, and don’t be afraid to ask for help if you’re having trouble understanding it. With a little bit of practice, you’ll be reading balance sheets like a pro manager in no time!

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