In addition to the profit and loss statement (P&L) and cash flow statement, balance sheets are one of three key financial statements businesses use to gauge their health and efficiency.
Today’s post will provide a brief guide to balance sheets so you can begin using them to make business decisions.
What Is a Balance Sheet?
The balance sheet is a snapshot of a company’s financial position at a specific point in time. It’s often contrasted to a P&L, which shows a company’s financial performance over time.
In short, a balance sheet displays what is owned (“assets”) and what is owed (“liabilities”), and any equity (the value of any shares issued by the company).
Illustrated with a simple formula:
Liabilities + Shareholders' Equity = Assets
At the simplest level, there are two primary types of assets:
current assets, defined as those that can be quickly and easily converted to cash, such as accounts receivable and inventory, and
non-current assets, which have longer lifespans, such as real estate, machinery, etc.; these are sometimes referred to as resources.
How Balance Sheets Impact Your Business
Balance sheets provide insight into your company’s financial health. Clearly seeing your assets and liabilities can be helpful for planning purposes and for strategizing in both the short- and long-term, to help make financial decisions.
The analysis of a balance sheet can reveal specific insights into operational efficiencies and financial strengths, to help you make decisions about your business. For instance, if a lender is considering whether to extend a line of credit, he or she would review the working capital ratio (the proportion of an entity's current assets to its current liabilities, which indicates whether a business can pay for its current liabilities with its current assets). If the business has a healthy ratio, the lender would then refer to the balance sheet to review how much of the company’s assets are in cash (liquid); the more liquid assets a company has, the more capable it is in paying off its debts.
The truth is, your balance sheet should be used in conjunction with the other two financial statements (i.e., income and cash flow statements) to get a complete picture of your company’s financial health. They’re used by lenders to assess loan applications; buyers and sellers use them in a merger and acquisitions negotiating process; and financial experts and partners use them to help make recommendations about financial management and operational improvements.
If you have any questions about how we help businesses prepare their balance sheets, among other important financial documents, contact us here.