Balance Sheet Concepts Every Business Owner Should Know

As a business owner, these are some of the most important concepts about the balance sheet that you should know.

Balance Sheet Concepts Every Business Owner Should KnowThis is the first of a series of posts on financial statement insight.  I’ll pick out some of the most important aspects of each financial statement and discuss their relation to other financial statements.  Financial statements might seem like a dry topic but it certainly doesn’t have to be.

Health Monitors For Your Business

Most successful business owners have a varied wealth of business knowledge they are able to employ when needed.  This includes knowledge of financial statements.  Think about a runner in a triathlon.  The runner might wear a monitor on his or her wrist for constant monitoring of blood pressure, miles ran, average speed and many other metrics.  Without the information, the runner might have some idea of how well they are doing.  But the pros will know exactly where they stand, how much progress they are making and what needs improvement. There is very little guesswork going on.

Financial statements are monitors for your business.  Once you understand them and how they relate to each other, you’ll know where your business stands – is it making progress, which products are doing well, and where your money is going.  Without financial statements, you are simply guessing.  There are too many details and variables for anyone to keep it all together in their head.  Use these monitors like a pro and on your way to getting pro results.

Of the three financial statements (balance, income, cashflow), we’re going to start with the balance sheet. Don’t worry, this isn’t going to be a boring, mundane post about all the nuances of financial statements. Instead, I’ll get right to the point and leave you with a few bricks to add to your entrepreneurial, financial intelligence foundation.

Financial Statement Time Frames

Balance Sheet – Point in Time

Income Statement – Range of Time

Cashflow Statement – Range of Time

Why Start With The Balance Sheet?

You might be wondering why I’m starting with the balance sheet and not the income statement.  Of the three statements, I view the balance sheet as the most important.  At a glance, you can tell if the business is worth anything and gain instant insight into its overall health.

This doesn’t mean you start with the balance sheet when preparing financial statements.  The income comes first when preparing.

Net worth can be used to determine an individual’s financial health. The balance sheet provides something called equity, which is similar to net worth for a business. Click To Tweet this line If assets are greater than liabilities, equity (or net worth) is positive.  Equity is also called book value.  Basically, the value of the business.

Assets > Liabilities = Positive net worth for the business

If you think about the balance sheet from an investment point of view, would you rather invest in a company that is able to pay off all of its debts if it had to (equity > liabilities) or one that was overwhelmed by debt (liabilities > equity) and possibly on the verge of bankruptcy?  There are exceptions of course.  Liabilities of a startups might be greater than equity but you don’t need a balance sheet to tell you if the business is a startup.

Where Does The Balance Sheet Fit In?

When preparing financial statements, it is usually done in this order:

  1. Income Statement
  2. Balance Sheet
  3. Cashflow Statement

There is also the statement of equity but for simplicity, we’re going to leave it out.  The balance sheet is based on a specific point in time.  In the image below, we have starting and ending balance sheets.  The income statement tells us what happened between these two periods.

Net income from the income statement is added (if positive) or subtracted (if negative) from the equity section of the balance sheet (right circle). If we continue to have positive net income, assuming liabilities aren’t increasing faster than net income, our company’s net worth will continue to increase.

Online Businesses And The Balance Sheet

Online businesses are not likely to have much in the way of assets or even liabilities for that matter. Assets might include your computer if you are only using it for business. But if your business is part-time, you are probably not using the computer 100% for business and thus can’t right it off as a business expense (in which case it would likely be depreciated instead of expensed). You may think your website domain name is an asset but you are renting it – an expense.

What about software – WordPress plugins, design software, video recording software, etc? Unless the software is expensive, it is also like to be an expense and not depreciated.

Liabilities usually mean accounts payable and loans. An online business might have an accounts payable for short time frame bills but isn’t likely to have loans. Like assets, liabilities are very small.

Small assets and liabilities means net profit is mostly going to equity on the balance sheet, increasing the book value or net worth of your business.

The above are just a few reasons I like light weight businesses so much – few expenses, lots of positive cash flow and continual building of equity.

The Takeaway

The balance sheet:

  • is based on a specific day
  • displays net worth of a business (through equity)
  • is able to tell you at a glance if a business is healthy or not
  • adds positive net income from the income statement to its equity (or subtracts for negative net income)
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