Understanding Your Balance Sheet: Assets, Liabilities and Equity
Updated: Jan 28
This is the first post in a series on understanding your financial statements. Today I will talk about the balance sheet, followed by the income statement and the statement of cash flows. Then I will end this series on how to analyze all three financial statements together to get an understanding and clear picture of your business finances.
The balance sheet is the first of the financial statements. This represents your business’ financial health at the end of a specific date. This can change daily and only represents your business at that moment in time. Many times, business owners just briefly look it over while not fully understanding what it means for their business.
The basic equation for the balance sheet is:
Each of those are broken down into further accounts.
Assets are what you own
An asset is anything of value your business controls. Assets are further classified into several accounts.
Current Assets – Cash and other resources that are expected to turn into cash within one year of the balance sheet date.
Investments – Funds in this account would be bond sinking funds, funds held for construction, cash surrender value of a life insurance policy or long-term investments in stocks and bonds.
Property, Plant, and Equipment – Such as land, buildings, leasehold improvements, equipment, furniture, or cars.
Intangible Assets – Include copyrights, patents, goodwill, tradenames, or trademarks.
Other Assets – Any other assets not included above.
Liabilities are what you owe
Liabilities are debts your business owes to other people. Liabilities are broken down into 2 separate areas.
Current Liabilities – Obligations due within one year of the balance sheet date.
Long Term Liabilities – Obligations that are not payable within one year of the balance sheet date.
Owners’ Equity is what is left over
Owner’s Equity – represents the portion of the business that you own free and clear.
For example, if you were to sell all your assets and then pay off all the debts you owed, the amount left over would be your “equity”. It also shows the amount of money a business owner has reinvested into the company or used to pay down debt.
Paid-In Capital – represents the initial investment of the business owner.
This section will vary depending on what type of business you own. If you are a corporation, you will have a common-stock account. If you have a partnership, you will have separate accounts for each partner. If you have a sole proprietor, you will have an owner’s equity account.
Why is the Balance Sheet Important?
The balance sheet is important for many reasons but mainly because it can show potential investors, banks, and business owners the true financial position of the company. The balance sheet shows the amount of assets the company owns and the liabilities the company owes; ideally having more assets than liabilities. It is important to monitor cash, accounts receivables, investments, equipment, and major liabilities.
Remember the balance sheet only gives you a picture of your financial health at a moment in time. It is ever changing. It shows your assets minus your liabilities and that equals your equity. Each aspect of the balance sheet works together to give you a financial picture of your business.
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