No matter what type of company they start, all small business owners need to have at least a basic familiarity with balance sheets. Balance sheets are straightforward documents which provide a snapshot of the financial condition of an individual or business.
Every small business owner should be able to look at a balance sheet and quickly grasp what it conveys.
This is true even for business owners who have professionals with a financial background on staff. The reason for this is because business owners must have a solid understanding of the financial condition of their company at all times in order to make sound decisions.
Balance sheets are typically organized such that they display the assets on one side of the sheet and the liabilities on the opposite side.
The equity is listed separately and shows how the assets and liabilities “balance out.”
Assets are usually subdivided by type – current and non-current.
- Current assets (or short-term assets) are things such as cash, cash equivalents, accounts receivable, inventory and prepaid expenses for future services.
- Non-current assets (or fixed assets) include things such as investment property, equipment, biological assets, patents, copyrights, notes receivable and others as well.
Like assets, liabilities also come in various sorts and kinds.
- Common kinds of liabilities include accounts payable, corporate bonds, promissory notes, provisions for court decisions and tax debts.
- When liabilities are subtracted from assets they show the equity of the company. Equity is generally listed on the same side of the sheet as liabilities, although it will have its own space or column.
- Equity represents the net worth or value of the entity.
- The equity section of a balance sheet will sometimes be broken down in order to show the various ownership interests in the company.
It may seem reasonable to just consider the equity of a company when trying to assess its general condition. However, looking at equity in isolation can be misleading.
Remember, balance sheets are time-specific documents and the various financial items they show may change value or disappear altogether at a later date. Business owners must examine all of the elements of balance sheets in concert in order to gather an accurate picture of their company.
Balance sheets must be prepared in accordance with particular accounting standards in order to ensure professionalism and readability. What’s more, balance sheets must also undergo a process of substantiation so as to guarantee maximal accuracy.
For the most part, small companies tend to have simple balance sheets which do not require a great deal of mental muscle to comprehend. The information provided here should be enough to prevent aspiring entrepreneurs from becoming intimidated by balance sheets as they prepare to launch their own business.
John Huddleston, CPA, JD, LLM, is the principal and founder of Huddleston Tax CPAs, a tax and accounting firm based in the greater Seattle area. Huddleston Tax CPAs focuses its practice on helping small business owners with their various needs.