Keeping a balance sheet is a useful healthy lifestyle, but not everyone likes it. Why? Maybe it seems too complicated or unnecessary, or there’s something related to accounting in the name, and as you know, it is better not to go there.
In reality, a balance sheet consisting of hundreds of lines can be left to specialists, while managers need a simpler and more transparent report. You can learn a lot about your business from it:
- it shows what the company owns and the amount of its debts;
- where the profit is “hidden”;
- how much money can be withdrawn from the business.
Jennifer Finlay, Owner and Director of an audit and accounting company:
“The balance sheet is the pinnacle of financial reporting, which reflects the company’s performance for the year, taking into account its assets and liabilities. It shows the growth or decline of the company’s capital, the structure of assets (what the company owns) and liabilities (who the company owes). If the business owner is able to “read” such a report, they can perform important analytics for strategic planning. Analytical coefficients are also calculated based on the balance sheet. They characterize investment attractiveness, solvency of the business, the ability to fulfill financial obligations to banks and other creditors”
Assets
Assets are what an organization owns and can generate a profit. Stock of goods, money on the account and in the cash register, property, website, licenses. Assets are divided into two groups: current and non-current.
Current assets change their shape during the financial cycle. These include money, inventory, and accounts receivable.
Accounts receivable — money that customers owe the company. If the company works with post-payment, customers receive the product first, and pay after some time. This money can no longer be considered finished products — it has left the warehouse, but it can’t be spent yet. The buyer can pay later.
The second group of assets is non — current. These are assets which maintain their form throughout the financial cycle, their distinctive features:
- they are used for a long time, have a service life of at least one year;
- they are expensive, but the company itself can determine which acquisitions are considered expensive and fix this in its policy.
Non-current assets are divided into two groups:
- fixed assets — tangible assets that can be “touched”: buildings, premises, equipment, transport;
- intangible assets that do not have a physical form, but they can be evaluated: licenses, websites, patents.
Assets don’t automatically bring profit. Finished products in the warehouse do not guarantee revenue, they still need to be sold. Every businessman hopes that the investment will pay off, but no one can guarantee it.
If a company is caught in a cash gap, you can always look at the balance sheet and see where the money is “hidden”. Large accounts receivable? Work with clients and reduce delays in payments. Too much stock? Conduct an inventory of your warehouses, optimize production, and give discounts on finished products. If all the funds are invested in non-current assets, you need to think about what you can part with.
Liabilities
Liabilities are the funds used to purchase assets and the sources that finance them. They consist of two large groups: equity and debt capital.
Equity — the company’s money: the founders ‘ investments and retained profits.
The Founders’ investments are what a business starts with.
Retained profits are the final result of the company’s operations for the reporting period.
The owner must decide where to spend this money: on paying dividends, paying off losses of previous years, creating a reserve capital or developing the company. If there are several owners, a meeting is held, usually once a year or quarter, and the decision is made collectively.
The second part of liabilities is borrowed or pledged capital. They can be long-term, for a period of one year or more, or short-term. Short-term liabilities also include accounts payable — the company’s debt to suppliers. The ratio of accounts receivable and payables helps to understand whether the company manages its own and borrowed funds correctly.
K = Total sum from accounts receivable / Total sum from accounts payable
The ideal coefficient value is one. If the ratio is higher, this indicates an outflow of money from circulation, as a result of which you may need borrowed funds. If it is less, the company’s financial position is threatened.
Andrew Mylott, A partner at a consulting company in the industrial and mining sector:
“The balance sheet shows:
— structure and dynamics of movement of assets and liabilities: the amount of funds “frozen” in accounts receivable, how much free money the company has, whether the company’s equity is growing, how much debt it has;
— comparability of the structure of assets and liabilities: whether the company has enough working capital to ensure the repayment of “short” accounts payable, whether the balance sheet structure allows attracting additional financing.
In addition, there is a set of important financial indicators that are calculated using data from the balance sheet, for example, net assets, liquidity, turnover”
To summarize
Assets are things that can make money. They can be current (cash, accounts receivable, inventory) and non-current (premises, transport, equipment).
Liabilities are what assets are financed from. These are equity and liabilities.
The most important balance sheet rule is that assets are equal to liabilities. This allows you to check that it is compiled correctly. Accountants sometimes joke that if the balance sheet doesn’t match up, there’s an error, and if it does, there are two. To avoid these errors, you can create a balance sheet in Finiqa. Assets and liabilities always match there, which saves the owner time and makes the business a healthier one.
