The main goal of any business is to make profits; therefore, it is not uncommon for most business owners to pay more attention to the income statement and forget about the balance sheet. These business owners prefer the income statement because it shows them the earnings after tax.
Interestingly, despite making profits, some business owners still find themselves short of cash and unable to account for some of the expenditure. If you are one of those people, it’s time for you to learn more about the balance sheet and embrace it.
What is a Balance Sheet?
A balance sheet is also known as a statement of financial position. It is used to monitor your firm’s finances and make sure that you don’t spend more than you can afford. The balance sheet shows what you own in the asset column and what you owe in the liability column. This financial statement also shows your net worth or equity on the liabilities column.
The Different Columns Explained
What you own is usually recorded on the left side of the balance sheet. There are two types of asset: current and fixed.
A smart business owner should be prepared for anything. Your current assets are those things that can be quickly converted to cash if a need arises. Any item that can be turned to cash in less than one year is a current asset. They include the cash that you have in your business bank account, any cash that you hope to receive from credit sales (accounts receivable), any goods that you plan to sell (Inventory), and insurance premiums that you have paid in advance (prepaid insurance).
On the other hand, fixed or non-current items are those assets that you intend to own for more than one year. You can even pass down some of these assets to your dependents as an inheritance. They include land, machinery, office equipment, and vehicles.
A liability is a debt. It is usually recorded on the right side of the balance sheet. Like assets, liabilities are also divided into two broad categories: current and long-term.
Any debt that does not go for more than a year is referred to as a current liability. They include things that you bought on credit (accounts payable), taxes, and short-term loans.
Long-term debt refers to loans that extend beyond 12 months.
After you subtract all the liabilities from the assets, you get your net worth or equity. It can also be referred to as the amount that you have invested in the business. This value can come in handy if you want to apply for a long-term loan. When you keep track of your equity, you avoid borrowing more than you can afford.
In conclusion, your firm’s balance sheet helps you keep track of your business’s financial position. It allows you to monitor debtors and make sure that they pay on time. It also enables you to manage your expenses so that you don’t default on loans.
If you have any additional questions on balance sheets, you can contact us.