Reflection of the Week

What is a Balance Sheet?

Hey, all! Happy Friday. I hope you had a wonderful Labor Day weekend and a relaxing week afterward.

I’ve had a couple of conversations with clients this week who didn’t know (and were somewhat afraid to ask) what a balance sheet was and why it’s necessary. So, today, I want to cover this fundamental document and the rationale for why I send it every month.

I promise to make this as painless and insightful as possible!

 

What is a Balance Sheet?

A balance sheet is a snapshot of your business’s financial health at a specific point in time. It’s like a photograph that captures everything your business owns and owes, along with the equity that belongs to you, the owner.

 

So, what does a balance sheet include?

A balance sheet has three main components: assets, liabilities, and equity. Assets are everything your business owns—think cash, inventory, equipment, and even accounts receivable. Liabilities, on the other hand, are what your business owes—like loans, credit card balances, and any other debts. Finally, equity represents the owner’s interest in the business after you subtract all liabilities from assets.

 

Why is the balance sheet important?

The balance sheet is crucial because it clearly shows what your business owns and owes. It helps you understand your business’s liquidity—how easily you can convert assets into cash to pay off liabilities. This awareness is crucial for assessing the financial stability of your business. A strong balance sheet can also make obtaining loans easier or attract investors because it demonstrates sound financial management.

 

How do you create a balance sheet?

Creating a balance sheet might sound intimidating, but it’s straightforward once you know what to include. Start by listing all your assets. Make sure to categorize them as either current assets—those that can be converted into cash within a year, like cash and accounts receivable—or long-term assets, like property and equipment.

Next, list your liabilities. Again, categorize them as current liabilities, which are due within a year, like accounts payable and short-term loans, or long-term liabilities, like mortgages or bonds.

Finally, calculate your equity by subtracting total liabilities from total assets. The formula is simple: Assets = Liabilities + equity. Once you have all these elements, you’ve got your balance sheet!

Of course, if you have accounting software like QuickBooks or Xero, you can pull your balance sheet in the Reports section. You can also use different dates like the previous month, year-to-date, or a couple of years.

 

Questions of the Week

• When was the last time you reviewed your balance sheet?
• Are there things on your balance sheet that seem out of place (e.g., you owe a lot on something you thought you were paying down)?
• Is there an asset or liability missing from your balance sheet?

 

Tool of the Week

This week’s tool is the balance sheet itself. Take some time to review yours to help you understand the health and wealth of your business.