Do you understand the parts of your balance sheet?
I believe it is essential to understanding your business and understanding your numbers.
For instance, did you know that you can have what we call negative equity on your balance sheet? Meaning that your business has a negative value?
If you are unsure of anything on your balance sheet, I would highly recommend scheduling an appointment with your accountant. And be on the lookout for my three-part explanation of the Balance Sheet.
Part One: Assets
Assets are anything in your business that you own or is owed to your or your business. Typically, on the balance sheet Assets are listed first and are listed in order of liquidity. Liquidity is the measurement of how fast you can turn something into cash. For example, on the balance sheet Cash accounts are typically listed first followed by Accounts Receivable. Accounts Receivable are invoices that you have not collected yet. Then, typically office equipment or computer equipment is listed next as it can be turned into cash relatively fast by selling. Next would be any larger assets that you may own such as a business vehicle. A vehicle can be turned into cash, but it takes more time. It is very important to keep an eye on the amount of assets you have in your business. Are your assets growing? If not, why not?
Part Two: Liabilities
Liabilities is anything that your business doesn’t own that is owed to someone else or someone else’s business. For example, credit cards, short-term loans, and long-term loans. All of these examples are funds owed to other parties. Typically, Liabilities are listed in order by due date. Short-term Liabilities first, followed by long-term liabilities. Accounts Payable or bills are also included in your Liabilities. Again, as with Assets, it is very important to keep an eye on your Liabilities. Is your business paying down debt?
Part Three: Equity
The Equity section of your balance sheet is probably the most important part of your business and the most important part of your balance sheet. The equity section reflects the simple value of your business. The equity section includes: paid-in capital, owners draw or distribution’s, current-year earnings, and retained earnings. I define all of these below:
Paid-in Capital- this is money or funds that the business owner puts up or contributes to start the business or later down the road if the company needs cash.
Owner’s draw or distributions- this is money or funds that the business owner takes out of the business for payment or salary. In addition, this can be personal expenses that the business owner pays for with business funds.
Current-year earnings-This line item is the one thing that connects your Income Statement to your Balance Sheet, your net income or current-year earnings is the money that the business has made or lost net of all expenses for the current fiscal year.
Retained Earnings-At the end of the year each year, your accountant should roll current year earnings into retained earnings. Therefore, retained earnings reflects the total earnings over the life of the business.