Why is the balance sheet important?
Most small businesses look at the profit and loss statement regularly, but many don’t understand the importance of the balance sheet.
What is a balance sheet?
A business’s balance sheet is a detailed list of its assets, liabilities (or money owed by the business), and the value of the shareholders’ equity (or net worth of the business) at a specific point in time. Assets are anything of value owned by the business; liabilities are debts owed to outside creditors or other parties; and shareholder’s equity is the amount owed to the business owners.
It’s called a balance sheet because assets must always equal liabilities plus shareholders’ equity: the two sides balance out.
Balance sheet classifications
Assets and liabilities are classified further to help you monitor your financial position. Both are broken down into “current’ and “non-current” to show how soon they must be turned into cash (assets) or repaid (liabilities). Current refers to a period of less than twelve months, while non-current refers to a time period greater than twelve months.
Current assets include cash and other items that will likely be turned into cash within a twelve-month period, such as accounts receivable (monies owed from customers or debtors) and stock and other assets to be sold within twelve months. Listed after current assets are fixed assets, which are assets that will continue to exist in their current form (not cash) for more than twelve months. Fixed assets can include office equipment, furniture, tools, company vehicles, and more.
Liabilities are listed on the balance sheet in order of how soon they must be repaid.
Current liabilities — those that must be repaid within twelve months — are listed first. Then non-current liabilities (due after twelve months) are listed, followed by shareholders’ funds (equity). Current liabilities typically include monies owed to suppliers, credit card debt and bank overdrafts. Non-current liabilities may include loans from external stakeholders.
Why is the balance sheet important to your business?
The balance sheet provides a picture of the financial health of a business at a given moment in time — usually the end of a month or financial year. It can tell you if you owe more money than what you currently have, the current value of your assets and the overall value of your business.
More importantly, if you familiarise yourself with using financial ratios, the balance sheet can provide warning signs so you can solve any problems before they destroy your business. The balance sheet is a vital financial statement you should be reviewing regularly, as it changes with every transaction.