Whether you’re new to business or a seasoned professional, you probably understand that one of the keys to success is having tools on hand that give you proper insight into your financial health. Of the many key financial statements that you should understand, the balance sheet should probably sit at the top of the list. It shows your company’s true financial position like no other instrument does.
What is a Balance Sheet?
If you’ve ever taken a basic accounting class, then you’ve been exposed to the formula for the balance sheet: assets = liabilities + owner’s equity.
While this seems simple enough, the key is to make sure you’re are putting the right items in each of these categories:
- Assets – These are the things of value your company owns.
- Liabilities – These are your business’s financial obligations or debts.
- Owner’s equity – These are your net assets, which include the shareholders’ or owner’s cumulative equity, including any shareholder distributions.
When the balance sheet is complete, you’ll get a final figure. When assets are less than liabilities, the company has a negative net worth. When they are greater, the net worth is positive.
Why Your Businesses’ Balance Sheet is Essential
Simply put, the balance sheet is critical because it gives you a single figure that indicates whether your business is operating in the black or in the red. It’s also important because it allows business owners to make informed decisions about strategy.
For example, taking on new debt might or might not be the best idea, depending on how it will impact the overall value of your business. If you ignore this figure and do take on too much debt, you could put your company in a precarious position in the short or long term.
Ways to Analyze Your Balance Sheet
In addition to providing a quick wellness update, your businesses’ balance sheet gives you information you can use to guide your strategic decisions. Managers use the data found on the balance sheet to help them measure the rate of return on investments and profitability.
If you want to make the best use of your balance sheet, here are the ways you can leverage the information it contains:
- Return on equity – Take your net income and divide it by shareholder’s equity to figure out how much money your businesses’ capital is generating.
- Return on assets – Figure this by dividing net income by total assets to learn how much money your firm’s assets are generating.
- Profit growth rate – Compare your accumulated profits over different periods to get your profit growth rate.
- Debt ratio – Figure this by taking your short-term liabilities divided by your total assets and then multiply by 100 to get a percentage. A higher ratio is a danger signal, and lower figures are better.
- Current ratio – This is similar to a debt ratio. This figure tells how liquid your business is by taking your current assets divided by your current liabilities.
Want to Learn More About Your Balance Sheets?
We understand that figuring out your businesses’ balance sheet can be challenging. If you would like to learn more about how to set up a balance sheet or have questions about keeping financial records, please contact Nolan Accounting for an appointment. We look forward to helping your business achieve and maintain success.