Owning your own business is no minor feat, kudos to you! The rewards are many, however, there is considerable work ahead. One of the most important aspects of any business is its financial position. There are a number of different accounting statements used to record business transactions, the most revealing being the Balance Sheet. A Balance Sheet provides a visual representation of what a business owns and owes. At any given time, you should be able to take a look at the balance sheet and determine the financial health of your business. Don’t worry, you do not need to be an accounting savant to generate and understand the Balance Sheet! Preparing a balance sheet is quick and easy using an accounting software. There are several available and most are very user-friendly. However, deciphering the story the Balance Sheet tells, requires a basic understanding of the accounting principles.
The Balance Sheet is an important tool regardless of the size of a business. Making decisions without knowledge of the company’s financial standing can lead to serious repercussions. Additionally, small businesses require significant financial resources to start and maintain the business. Therefore, it is the owner’s responsibility to source funding. Lenders and investors examine the financial statements of a business prior to lending. This helps to determine the company’s ability to repay loans and assess the credit-worthiness of the business. Let’s take a look at the components of the Balance Sheet.
Total Current Assets
Plant and equipment
Total Non-Current Assets
Total Current Liabilities
Total Non-Current Liabilities
TOTAL LIABILITIES AND EQUITY
A Balance Sheet can be summarized in simple terms as follows:
What you have (Assets)
Who you owe (Liabilities)
What you put in (Capital or Equity)
The Balance Sheet is so named because it is supposed to balance. The sum of your assets should be the same as the sum of your liabilities and equity. Just remember this handy equation:
Assets= Liabilities + Equity
The first section of the balance sheet consists of “What you have” which are known as Assets. There are two classifications of assets, current and non-current. The major difference between the two categories is the ease with which you can convert the asset to cash within the short term, usually not exceeding a year.
It is important to note that there will be items that sometimes fall under both current and non-current categories. Just a quick example:
Owner invested $200,000 for 1 year and an additional $500,000 for 4 years. Both investments are assets but the investment that matures in a year represents a current asset while the 4-year investment is classified as a non-current asset.
Current assets are meant to assist with funding the day to day operations of the business.Using the above example, we see that cash, accounts receivable and inventory are the current assets for this business. Cash can be money in the bank or cash that you have on hand. Accounts receivable or Trade Debtors, consists of customers that owe money for goods purchased on credit. Inventory or stock are items that are purchased for resale. So, if you own a book store, your inventory is books. A quick note, there are business owners whose business is providing a service and not a product. As such, the inventory would be any item that is used to produce the service. Here are a two examples to illustrate:
A hairdresser’s inventory would include shampoo, hair dyes, hair dryers.
A hospital’s inventory would be bandages, medication, surgical instruments.
Non-current assets are purchased with the intention of accruing benefits over the long-term. Using our example:
Motor vehicles purchased to deliver goods to customers is an asset that benefits the business. However, the purpose of the vehicle is to deliver goods for as long as possible and not to be sold for cash to cover operational expenses.
Property represents a building or premises that was purchased to facilitate the business operations. Plant and equipment can include machinery, office equipment and fixtures and fittings.
Nobody likes to be indebted, but liabilities are a necessary evil in starting and maintaining a business. Liabilities are “who you owe” and also have a current and non-current designation. Similar to assets, current and non-current liabilities are differentiated by the timing of the liability. Accounts payable also called Trade Creditors, is the amount you owe suppliers for goods purchased. Bank overdrafts are not ideal, but can prevent penalties from late payments that might occur because of lack of sufficient funds. This is money owed to the bank, it is therefore considered a liability.
For a small business, loans are the most common type of non-current liabilities. As mentioned earlier, non-current loans are not payable within a year. The purpose of these loans can include purchasing premises or equipment for the business.
Owner’s equity shows the amount invested in the business by the owner less any personal monies withdrawn. This is also the section where any profit or loss made from the business is reflected.
The items under each classification is not exhaustive, you can have more or less in each category. Provided that the principles are adhered to, determining the category for each will be a breeze!
So you might be asking yourself, where do the figures come from? Great question! Always remember to keep records of every transaction you complete. Receipts, invoices, deposit slips, any transaction that gives a monetary benefit or expense, keep the paper work! This is where the information for the Balance Sheet is located. There is however an exception, the net profit or loss is derived from another financial statement, the Income Statement. Also, ensure that financial documents are completed correctly. The date of the transaction, the amount and any other relevant information regarding the transaction should be noted.
It is okay if you still don’t get it, don’t despair! Procure the services of an accountant, and since most small businesses are cash-strapped; the accountant does not have to be a full- time hire. There are many accountants that charge on an hourly basis. Preparing a balance sheet does not have to be an arduous task, with proper record keeping
and periodic evaluations; you’ll be balancing the books in no time!