What is a balance sheet?
A balance sheet (also called a Statement of Financial Position) provides a snapshot of a business’ assets, liabilities, and net worth at a specific point in time. This ‘net worth’ is represented as shareholders’ or owner’s equity.
Assets are anything of value owned by the business and can include bank accounts, stock, trade debtors and items of equipment.
Liabilities are debts owed to outside creditors or other parties and can include bank overdrafts, trade creditors, business loans, loans to directors, employee entitlements and ATO debts.
Why is the balance sheet important to your business?
The balance sheet provides a picture of the financial health of a business at a given moment in time — usually the end of a quarter or financial year. It can tell you if you owe more money than you currently have, or if you don’t have enough liquid assets to meet short-term liabilities. Importantly for most business owners it will let you know the overall value of your business.
Given this it is imperative that business owners are examining their balance sheet on a regular basis to identify errors or areas of concern. Incorrect classifications on the balance sheet can mean corresponding errors in the profit and loss, leading to incorrect tax and GST calculations. If your balance sheet reveals that your liabilities are getting to be greater than your assets, your business may be heading towards insolvency.
Financial institutions will certainly look to the strength of a balance sheet just as much as a healthy profit and loss when assessing financial viability to repay debt. Plus a better understanding of your balance sheet can foster more in-depth analysis of your business through the use of financial ratios. These ratios may identify potential cash-flow shortfalls, excessively long delays in collection of debtors, or even issues with pricing.
Balance sheets also help current and potential owners / investors better understand where their funding will go and what they can expect to receive in the future.
A final thought.
Understanding how assets, liabilities and equity work together on a balance sheet can provide you with enough knowledge to identify warning signs within your business before it cripples you. Early identification is imperative so that timely changes can be made and strategies implemented to give your business the best shot at success!
To discuss how your balance sheet may be affecting your business, talk with us so we can help dissect the important information and you can work out if we're the right fit for you.
Whatever you decide we wish you every success!