Part of running a business is knowing where you are at financially and where you are headed. The purpose of accounting is to track and organize your financial activity, so that you can effectively manage your finances and produce reports to better understand what is happening with your company. If you are using any type of accounting program, you already have the ability to produce the key reports needed to understand and manage your business. The three key financial reports are:
- Balance Sheet
- Income Statement (also known as Profit & Loss Statement)
- Cash Flow Statement
Over the next few newsletters, I will discuss each of the three key reports in detail, so you can understand what they tell you about your business and how to use the information to better manage your business. This month's report is the Balance Sheet.
The balance sheet is a snapshot of your business on a given day (typically the last day of the accounting period [i.e. month, quarter, year]). It shows you the value of what your business owns (assets), what your business owes (liabilities), and what your business is worth (equity). The reason it is called a "balance" sheet is that the two sections of the balance sheet should always equal each other (be "in balance" with each other). A simple equation for remembering how it should balance is Assets = Liabilities + Equity. Another way to look at it is Assets - Liabilities = Equity, or what you own minus what you owe is equal to the net worth of the business. So the next time you want to know what your business is worth, look at the equity section of your balance sheet.
The balance sheet shows you how healthy your business is. If your business has a lot of debt, your liabilities will be relatively large, and your equity will be small. That means that most of your assets were funded with borrowed money. This could spell trouble for your business if you experience a downturn and are unable to meet your loan obligations or pay your current debts. It also means that you are most likely paying interest on the debt, which reduces your business's over all income. On the other hand, if you business has little debt and relatively large equity, that means you've built up years worth of earnings that have been, in essence, reinvested in the company. Equity can help you weather the storm if the economy takes a sudden downturn, like we saw a few years ago.
There is a reason that banks often want to see both a balance sheet and a profit & loss statement. They are looking for the health of your business, not just the income-producing power you have. If your balance sheet is not as healthy-looking as you want, you can take measures to improve it by working to pay down debt and/or to infuse the business with investor capital.
If your balance sheet is not in balance, then your balance sheet is not accurate and you should take immediate steps to correct the problem that is causing the out of balance situation. It may stem from an incorrect set up of your accounting program, or it may be due to accounting data that was entered incorrectly. Getting help from an accounting professional, like me, can quickly correct the issue and get you back on track.
Most of all, be sure review your balance sheet every month. You'll be surprised how much you'll learn about your business as you see the changes from month to month, and you will be better at spotting problems and can take action in a timely manner.
Next month we'll take an in-depth look at the Income Statement and its relationship to the Balance Sheet.
If you use QuickBooks Online, you may want to check out the free mobile apps for ipadŽ, iphoneŽ or Android™/Tablet. With these free mobile apps, you can: