How to Confidently Understand a Balance Sheet for Small Business Owners

October 6, 2022
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Business Basics

If you’re a small business owner, you know how challenging it can be to get a handle on your finances. Maybe you work with an accountant or use accounting software for precisely that reason.

But even if someone else is taking care of your finances, you still need to know what they look like so that you can make informed decisions about how you run your company.

That’s why being able to read a balance sheet is so important. We’ve put together this article to help you do it. Keep reading to learn everything you need to know about balance sheets, how to read them, and why doing so will help your business thrive.

What is a Balance Sheet?

A balance sheet is like a snapshot of your company’s financial health. It covers everything that you need to know in order to figure out things like:

  • How prepared your business is for expansion
  • What kind of debt obligations you have
  • How attractive the company may be to outside investors
  • And more

What’s on a Balance Sheet?

Your company’s balance sheet provides three key pieces of information:

  1. Assets: An asset is something your business owns that has monetary value with the expectation that it will provide a future benefit. The most accessible type of asset to remember is money. Cold hard cash intrinsically has value. So, your bank account is an asset. Land, equipment and investments are all assets as well because they are a store of value.
  2. Liabilities: A liability is a monetary value you are obligated to pay someone else, sacrificing economic benefit to other businesses. The most common type of liability? Credit cards. Credit is a promise to pay for something in the future - effectively an IOU. That means loans and other money your business owes to someone else is a liability.
  3. Equity: Equity calculates the monetary value you have left over after all liabilities have been satisfied. Equity will always be equal to your assets minus your liabilities! For this reason, things like your net income or money invested into the business are forms of Equity.

Each of these main categories may have one or more sub-categories underneath it based on the nature of your company and its financial health.

For example, under assets, you could list cash, property, supplies, and other receivables. Under liabilities, you might list business loans, income taxes, accounts payable, and related items.

Balance sheets can be highly complex or very simple. It all comes down to how complicated your company’s finances are as well as the layout of your Chart of Accounts.

How to Read a Balance Sheet as a Small Business Owner

Reading a balance sheet can feel like a complicated task if you’ve never done it before. But it’s actually fairly straightforward in most cases. Here are some things to keep in mind while you take a look at yours.

Assets are Listed First, Liabilities, and Equity on the Come Next

Most balance sheets follow the same basic format. On top, you'll find all company assets listed. Again, these are items such as cash, property, and any receivables.

Beneath the your list of assets is where you’ll find liabilities and equity.

Once you know this format it’s easy to orient yourself whenever you look at a new balance sheet for the first time. You’ll know exactly where to look on the page for each piece of information.

Assets = Liabilities + Equity

The balance sheet is an expression of the basic accounting equation: assets = liabilities + equity. Think about it this way: your business doesn’t just get assets from nowhere. Sales generate cash and cash equivelants. When companies own larger assets, like buildings and equipment, they're often purchased using liabilities (like debt). Alternatively, the owners of a business can invest their own money into the company in exchange for equity.

For example, a company may have $700,000 in assets. If you know that $400,000 of that comes from liabilities, then it’s a foregone conclusion that there’s a total of $300,000 equity. Some of that equity has been put into the business by one or more investors and some has been generated by the business itself through sales.

Analysts Use Ratios to Understand Balance Sheets

When the balance sheet is simple, it’s easy enough to get a sense of the company’s financial health just by looking at it. But for more complicated sheets, analysts will use a variety of ratios to evaluate the business and compare it to others in the industry.

One of the most common is debt-to-equity. This is a ratio that’s calculated by dividing total liabilities by total equity. There are other ratios, too, and it may be worth doing further research into them if you’re interested in learning even more about your company’s financial health.

Why Reading Your Balance Sheet Is Important

Now that we know what a balance sheet is and how to read one, it’s worth taking a moment to review why you’d want to do this. Here are a few reasons.

Balance Sheets Help You Track Financial Progress Over Time

Balance sheets are typically created at set time intervals, such as every quarter, half year, and year; they're an "as-of" report. Looking at balance sheets from successive quarters or years is a good way to get an overview of how your company’s financial health has evolved over time.

For example, you might discover that in 2019 your liabilities were much higher than in 2020, even though the total assets are around the same level. This is a way to show that you’re making progress when it might not be immediately obvious that you are if you’re just looking at what your company owns.

C Corporations Must File a Balance Sheet with Their Annual Tax Returns

It’s also important to note that C corporations must file a balance sheet with their tax returns. If you run a corporation, you’ll want to look at your balance sheet before submitting your taxes to avoid costly mistakes.

Your Balance Sheet Helps You Prioritize Your Growth Strategy

Finally, you can use what you learn from reading your balance sheet to plan out your future business strategy.

For example, you may look at a balance sheet for one quarter and notice that your liabilities are especially high. That could lead to you spending the next quarter focusing on bringing down some of those liabilities so that your company has a greater operating budget.

Or, maybe you’ll find that your company is in especially good financial shape after reading your latest balance sheet. That could be a sign that it’s time to start thinking more seriously about expansion and growth.

It’s also worth mentioning that lenders will typically want to see a balance sheet before giving your company money. So if you go into those lending meetings with a keen understanding of what your balance sheet says, it should be easier to explain your financial situation in a way that will resonate with potential lenders.

Kellan Jansen
Written by:
Kellan Jansen

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