The Balance Sheet Revealed (No Accounting Class Necessary)
If you can appreciate your income statement, but really don’t understand fully how to read your balance sheet, you are likely part of the majority. Hopefully, after reading this article, you’ll not only begin to read your balance sheet with understanding but insist on using it. A quick glance at the balance sheet can give a basic indication of if your company has value or not and how fragile it appears to banks and investors.
Assets on the balance sheet are pretty close to the same definition we use in everyday life. This section is a snapshot of most everything of measurable value that your business owns. Here are my own simple definitions:
Cash – Best if it’s a positive number. Cash should include balances in business checking, savings and petty cash.
Undeposited funds – Money received and not yet deposited. Perhaps it’s a timing difference. Maybe there are checks sitting in a drawer.
Accounts receivable – Money you haven’t received yet from invoices to customers or from contracts.
Reveal: This amount is already shown as income on your income statement!
Inventory – Items you will later sell. If you are manufacturing goods, you might also have raw materials or components as part of your inventory.
Goods in transit – Items you’ve purchased for inventory that have not arrived yet.
Reveal: If your business purchases goods that take a while to show up frequently but you don’t see a “Goods in Transit” category, check in with your accounting department. They might be marking those purchases as inventory right away, but that can be a big difference for some companies and confusing at year end.
Work in Process – Work you are performing (contracts) that is not yet complete.
Furniture, Fixtures and Equipment – Most anything you see in the office, shop, fleet, big pieces of equipment.
Reveal: This amount does not include any amounts that were shown as an expense on the income statement already. Anything in this category has been “capitalized.”
Accumulated Depreciation – The total amount your assets have lost value according to a calculation your accountant determines at the time the asset is capitalized. This figure is usually a non-cash figure.
Reveal: The amount added to accumulated depreciation is shown as a depreciation expense on the income statement, every time it is added.
Net Assets – Furniture, fixtures and equipment less depreciation. This number may give you some insight into how old your asset base is.
Prepaid and Deposits – Items like insurance you’ve paid ahead of time.
Reveal: These are amounts that have not yet hit the income statement. For instance, if you paid your insurance a year ahead, instead of having it hit the income statement all at once, you can expense 1/12th of it every month.
Similar to assets, the liability section is pretty close to the same definition we use in everyday life. This section is a snapshot of most everything that you owe or that might reduce the value of an asset. Here are some simple definitions:
Notes and Loans – You owe banks or people money and it’s reflected here.
Deposits (from clients) – Deposits from clients before the work is performed or before the money is earned by you are considered a liability.
Don’t freak out. This is the section that scares everyone off the balance sheet, needlessly. Total stockholder’s equity, also known as “Net Worth”, is basically reflective of what the company is worth after subtracting liabilities from your assets.
Reveal: A negative stockholder’s equity amount will result if the company has more liabilities than assets and it is positive if the opposite is true.
Retained earnings – It’s helpful to understand that retained earnings, simply stated, is all of the income the company has generated on the income statement to date. Often, you’ll see retained earnings and net income listed separately as part of the equity section. In that case, retained earnings represents all income earned prior to the current year and net income is a statement of the current year’s income to date. If the owners decide to take a distribution of income, not included in payroll, retained earnings will be reduced.
Stock – You’ll see values indicated for any common stock or preferred shares you have issued in this section. The type of value used, depends on various company specific factors.
What does it all mean?
My next article will discuss using the income statement and balance sheet information to answer questions like “How are we doing?” “How do we look to banks and investors?” “Do our financials look strong enough?” “How much debt can we afford?”
If you missed my article on income statements, go to A useful Income Statement here.
Kira Spivak, founder of CFO Services, has been easing the minds of CEOs and their investors for 19 years. After gaining experience as the Manager of Equipment and Assets for Brannan Sand & Gravel Company and Director of Finance for Renewable Choice Energy, Kira founded CFO Services, LLC in 2007. Ms. Spivak is currently the CFO for Rocky Mountain Excavating and Concrete, Inc., where she has enjoyed the growth phases of transitioning from a small to mid-sized business through challenging economic times. In addition, CFO Services continues to provide financial solutions to corporate clients and investors in a variety of industries.