The Balance Sheet Explained

Octavia Conner

By Octavia Conner

Tags: All, Accounting

To become a profitable consultant, you must have the skills to read, understand and use financial statements to your advantage.

The balance sheet helps CEOs understand the financial position of the company on any given date.

Today, I will explain the balance sheet so that you are equipped to use it as a decision-making tool in your firm.

 

 

The Balance Sheet provides a snapshot of the company's financial strength.

 

You can not have a healthy business if you do not have a healthy balance sheet. PERIOD

 

This snapshot report enables you to identify the trends in your business's finances and if the company is stable enough to expand. 

 

In addition, your ability to reduce risk and maximize returns lies within the lines on the balance sheet lines.

 

3 Components Of The Balance Sheet

The Balance Sheet Explained

What Are Assets?  

Assets are resources the business owns. The assets are listed based on their liquidity. Meaning they are listed based on how easy the asset can be converted into cash. 

  1. Current Assets
    1. Bank Accounts
    2. Account Receivable - money your clients own you. You have issued invoices in most cases, but your clients have yet to process the payments. 
  2. Other Current Assets - are items the company owns that can be converted into cash within one business cycle (generally within one year) 
    1. Inventory - are goods available for sale. An excess of inventory is like having money on the floor. I need you to pick that up and put it in your bank account. okay
    2. Prepaid Expenses - are the value of expenses you paid in advance, such as rent and insurance.
  3. Long-term Assets - are items the company expects to use, replace or/and convert to cash beyond one business cycle.
    1. Fixed assets - are tangible assets such as property, equipment, machinery.
    2. Intangible assets - are non-physical assets such as goodwill, trademarks, and intellectual property. For most consultants, you will not see intangible assets on the balance sheet unless they are purchased. 

When you add the current assets and non-current assets, you arrive at the Total Assets. 

 

The assets form the left side of the balance sheet, which must equal the right side of the balance. 

 

Moving to the right side of the balance sheet, you have liabilities and equity.

 

What are Liabilities? 

Liabilities are monies that the company owes. It is the debt owed by the business to others. Current liabilities are those due within one year and are generally listed in the order of their due date. Long-term liabilities are due beyond one year. 

  1. Accounts Payable - These are amounts owed to the company's vendors or suppliers. 
  2. Credit Cards
  3. Payroll Liabilities 
  4. Short-term loans

Most consultants incur many of their liabilities by purchasing items on credit to fund the business operations.

 

When you add the current liabilities and long-term liabilities, you arrive at the Total Liabilities. 

 

What Is Equity? 

Equity on the balance sheet is the amount of money available after all liabilities have been paid. It is the ownership interest in the company.

 

A consultant's equity represents retained earnings and funds contributed by its owners or shareholders (capital).

  1. Open Balance Equity - Opening balance equity is the account used to offset the opening of new accounts. 
  2. Retained Earnings - This account is used to track all profits from prior years minus any losses or dividends. You should avoid using this account unless you are writing off or adjusting entries from prior years. 
  3. Net Income - Will carry over from your profit & Loss Statement.  

 

Those are the three components of the balance sheet.

 

The Balance Sheet Formula

The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity

Accounting Equation

On most balance sheets, the left side of the balance sheet outlines all of a company's assets. The right side of the balance sheet summarizes the company's liabilities and shareholders' equity.

 

How to Read a Balance Sheet

 

If a company's liabilities exceed its assets, the company is operating upside down. 

 

In this position, the company is operating off of its credit cards and loans. 

 

The goal for a company operating in this position would be to increase revenue, maintain a positive cash flow and reduce debt. 

The Balance Sheet Explained

 

SUMMARY OF THE BALANCE SHEET

 

The balance sheet is used to determine if the business has enough working capital to sustain its operation.

 

The balance sheet also enables you to determine what the company is worth. And it is a great reality check to identify if the company is financially sound and stable. 

 

Balance sheets are used internally to guide management decisions. Externally, they can be used to report your business's financial status to lenders, investors, and other stakeholders.

 

Diligently tracking your company's finances can help you identify potential issues before they turn into major problems. In fact, 29 percent of small businesses fail due to a lack of cash flow. Ultimately, a balance sheet provides the information you need to sustain and grow your business over time. 

 

Say Yes To Profits Plan

The balance will help you
  1. Determine risk and return
  2. Secure business loans and capital
  3. Identify healthy financial ratios 
  4. And more...

 

As an additional resource to help you improve your Balance Sheet, click the image to download the SYTP Plan. 

 

 

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