The financial side of running your own business can be a steep learning curve for many entrepreneurs. There are a lot of documents required to keep an accurate account of how much money you are spending, making, and what your company is actually worth. It is a lot more complicated than just balancing a checkbook.
One of those documents that is a mystery to non-accountants everywhere is the balance sheet. A balance sheet is a simple statement that provides a snapshot of your company’s assets (what you have) and who owns them (you or someone else). It is based on a simple equation: Assets = Liabilities + Owner’s Equity, and it looks something like the illustration below.
Assets are things that bring value to the company. They can include cash, equipment, inventory, outstanding balances people owe you (your accounts receivable), or vehicles. For the balance sheet, it doesn’t matter if you actually own an asset. If it is being used for the company, it goes on the asset list. The ownership of it comes in later.
Let’s say you purchase a new high-end laptop and finance it through your credit card. That is still an asset that gets recorded as equipment. You are in debt to the credit card company, but you still record the value of the laptop under assets on the balance sheet.
Liabilities are things you owe to other people. Take the credit card balance for that laptop in the assets column. That is recorded here. Other things you would include here would be paying back a business loan or if you had an outstanding invoice on manufacturing supplies.
Owner’s equity is what you “own” in the company so to speak. It is what is left after you subtract what you owe from what you have. Basically if you took the value of everything in your company and paid off all your debt, what would you have left? That is you owner’s equity.
Let’s go back to that laptop. In a month, the manufacturer releases a new model. It is now worth $2,500, but you have paid off $2,000. You would lower your credit card debt to $1,000, your equipment item to $2,500 and your cash to $10,000. Since the laptops value changed though, you would also need to adjust your owner’s equity to reflect that change. So your balance sheet would now look like this:
The owner’s equity stayed fairly even in this example because you were essentially paying off your debt, but your asset was depreciating. We will get more into depreciation in another article but wanted to provide an example of change of value impacting the balance sheet. Let’s say you dropped the laptop and broke it before paying the debt off. Where would the price for the laptop impact then? It would be taken directly from the owner’s equity since you still owe the money. If that was the case, your balance sheet would look something like this:
As you can see, a balance sheet is a great way to see how outside factors and internal decisions are impacting the more abstract financial areas of your business. It is also a great way to gauge the health of the business. Do you have a lot of assets but not a lot of debt? Things are going well. If you end up with a negative in owner’s equity, things have gone very wrong. Simply put, a balance sheet is a snapshot of a company’s assets and who owns them, someone else or the owner.
There is more that goes into running a company’s financials, but we hope this helps with preparing and reading balance sheets in the future. Check out our other financial resources or reach out to us at email@example.com with your questions!