Read a Balance Sheet

A balance sheet is a snapshot of a business's financial health on any given day. It is a detailed document of what a business owns, what it owes, and who that money belongs to. Though there is some tricky terminology, balance sheets come down to balancing three numbers: the amount of assets (things of value), the amount of liabilities (debt), and owner equity (the owner's share of the company).

Steps

Calculating Your Assets

  1. Know that assets are anything of value owned by the company. Assets are valuable resources that you own or control, from cash and manufacturing equipment to the company car. They are sometimes called "debits." In a column labeled "Assets," list each asset and its worth.
    • The easiest asset to calculate is cash. How much money could your business spend at any moment without a loan or credit card? Write this down as "Cash."
  2. Calculate how much money your inventory is worth. Inventory is the total supply of your product. If I sell dog food, for instance, my inventory would be every bag of food in my stores. Calculate how much money you would make if you sold every single bag at normal price.
    • For example, if I sell each bag for $5, and I have 2,000 bags in my warehouse, my inventory is worth $10,000.
  3. Calculate the worth of your equipment. Your business's property, manufacturing plant and equipment are all essential to your business, but could be sold. If you are still paying the mortgage on a $200,000 property, for example, you would still list a $200,000 property under assets.
    • If the market value for my high-end food processor, oven, and refrigerator is $5,000, I would note $5,000 under "equipment."
    • If you rent your equipment or space, and could not sell, then it is not an asset.
  4. Include any money you are owed as "Account Receivable." When someone owes you money you can claim it as an asset, even if you do not know when you will be paid back. This is "accounts receivable," or "A/R," because you can count on receiving the money.
    • Many businesses include an "allowance" in parenthesis, admitting that some debts may not be paid back. If I know that a pet food store owed me $1,000 and went out of business, I might note this next to "Accounts Receivable."
  5. Note the amount of money in investments. Though this is not accessed as readily as cash, any investments a business makes are expected return a profit are and are thus assets. Write down the amount you expect to yield (or make) from your investment as an asset.
  6. Consider pre-paid expenses as assets. If you've paid your bills in advance, whether buying your ingredients for 6 months in bulk or purchasing plane tickets for next year's trade conference, you can list these as assets under "pre-paid expenses." While you usually can't sell them, they represent money you will not have to spend again, meaning you can save more of your profits later on.
  7. Intangibles that cannot be easily sold, like brands, trademarks, and patents, are are not assets. These cannot be readily valued and thus are arbitrary figures. Intangibles may be worth a great amount of money, but they are not added to a balance sheet. Their value lies in their ability to generate a profit and are listed in an income statement.
  8. Know that even partial ownership of something makes it an asset. You must list the full worth of assets you don't fully own. For example -- if I buy a delivery truck worth $60,000, but took out a loan for $30,000 to pay for it, I must still list the truck as an asset worth $60,000.
    • This is true for mortgages too -- no matter how much money I still owe on a $500,000 factory, that factory is still a $500,000 asset for my business.
  9. List all your assets on one side of a balance sheet and add them together. This number represents your business's total assets, or everything of value in your company.

Calculating Total Liability

  1. Understand that liability represents your company's debts. Liabilities are obligations of the business to pay something or someone in the future. It includes credit card debt, mortgage payments, business expenses, loans, and bills.
    • Liability is the money that you turn into assets -- for example, you need to take out a loan build a factory. The loan is the liability, the factory is the asset.
  2. Make columns on your balance sheet for short-term and long-term liability. Separating debts that need to be paid soon from those that can wait helps show the stability of your company. If you owe a lot of credit-card debt, for example, you need to find a way to pay it off before a 30-year mortgage.[1]
    • If you need to pay the debt within one year it is short-term, or "current," liability. Anything else is long-term.
  3. Calculate your 'accounts payable," or the debts you owe to other businesses. An example would be buying ingredients from a company regularly, but paying them back after you've sold your product. These are usually due within one year and are thus "short-term liabilities."
  4. Calculate any loans or mortgages, and interest due. Generally, a loan is a long-term liability, but regular interest payments are short-term.
    • You do not mark the full loan as liability, only the amount you still owe.
  5. Note any "accrued expenses," like taxes or bills. These are usually the expenses that you know you have to pay but haven't been charged yet. Often this is extrapolated from past years' expenses. If, for example, you know that your equipment needs maintenance and repair every year, you can mark it on your balance sheet now to plan for the future.
    • Bills, insurance, and income tax are all possible accrued expenses.
  6. List all your liability next to your assets. Once you have noted every debt, expense, and liability, list it on your balance sheet. Many business put it next to the assets so they can easily compare the two numbers. #Add up your current, long-term, and total liability. This is your total liability, or every debt your business owes.
    • Be thorough when listing liability -- suddenly realizing you missed a large payment or debt can derail your company if you are not careful.

Making Sense of Your Balance Sheet

  1. Subtract your liability from your assets to find "ownership equity." Equity is the amount of money the owners (you, shareholders, etc.) have invested in the business. It represents how much the company is worth if it sold every asset and paid back every debt. Equity is how much money you would make if you sold the business at it's exact cost.
    • If equity is negative (more liability than assets), then the company is in debt.
    • Example: I bought a $200,000 house and paid $25,000 for it up front. I take out a loan for $175,000. I could us a balance sheet to determine my Home Equity:
      • Assets: House, $200,000
      • Liability: Mortgage, $175,000.
      • Home Equity: Assets - Liability = $25,000.
  2. Remember that assets ALWAYS equal liability and equity. This is an iron-clad rule of accounting: Assets = Liability + Ownership Equity. This is why it is a balance sheet -- because both sides are always balanced. So, if one side goes up, so does the other. For example, if my company gets a tax return of $2,500, and I don't owe any more money because of it, than my equity just went up $2,500. This way the sheet stays "balanced."
  3. Calculate the "current ratio" to determine how much money a company can spare for growth. To do so, divide the assets by the current liability. This will return a number, usually between .5 and 2, that tells you how many spare assets the company has to grow or pay back debt. Generally, a current ratio above above 1.5 is a good goal.[2]
    • If this ratio is below 1 then the company is spending more money on short-term debt than it has saved in assets.
    • If my dog food company has $20,000 in assets and owes $10,000 in liability, my current ratio would be 2. This means that I have twice as much money I could spend as I owe. Remember, however, that not all assets are easily converted into cash.
  4. Calculate the "quick ratio" to determine a company's finances if it stopped making sales. Because inventory is often sold for a different price than it is worth (during a 50% off sale, for example) it can inflate your assets and make the company look stronger than it is. The quick rate subtracts inventory from assets, then divides that number by the current liability.
    • The quick ratio is helpful for determining the health of a company that may fluctuate sales numbers depending on current trends, like fashion or music sellers.
    • Healthy businesses will have a quick ratio greater than one.
    • If my dog food company has $20,000 in assets, but $5,000 of those assets are the projected sales of kibble, then I would assume I have only $15,000 in assets. I could then divide by my total liability to find the quick ratio.
  5. Update you balance sheet 1-4 times a year. The balance sheet provides a snapshot of your companies health, and while it may help prepare for the future, it does not predict it. You need to have accurate balance sheets often to help you manage debt, convert assets into growth, and see detect financial problems before they become too large to manage.
    • Commonly, businesses will prepare quarterly balance sheets-- or one every 3 months.

Tips

  • Note that four types of transactions affect owners’ equity; owner contributions, owner withdrawals, revenues and expenses.
  • Assets will ALWAYS equal liability + equity.
  • Most business's calculate their business sheet between 1 and 4 times a year.

Warnings

  • A big number in the asset column is not a good thing if there are a lot of associated loans as well.

Related Articles

Sources and Citations

  1. ↑ http://www.investopedia.com/terms/l/longtermliabilities.asp
  2. ↑ http://www.apapracticecentral.org/business/finances/balance-sheet.aspx
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