Can You Read Your Balance Sheet?
Are you able to read and understand your balance sheet? “This is an easy question, isn’t it? Maybe not. You know the formula, Assets = Liabilities + Owner’s Equity. As long as it is in balance then everything is okay, right? Maybe not. It is important as a business owner you understand what the figures on your balance sheet are telling you.
Assets are the first section on the balance sheet. Your current assets are listed first. Current assets are cash or cash equivalents that can be expected to be converted to cash within a year. Your bank accounts are listed first and the normal balance will be a debit. If any of your bank accounts show a credit balance, that account is overdrawn as of the date of the balance sheet.
Accounts receivable will be the next current assets on your balance sheet. This account will have a debit balance. You will want to keep track of how many times your accounts receivable have been collected during an accounting period. This is called an Accounts Receivable Turnover Ratio. The better the ratio, the better you are using your assets.
The next group of current assets will depend on your type of business. They may be customer deposits, prepaid expenses, inventory, employee advances, etc. They should all have a debit balance and you can convert them into cash within a year.
The last group of assets will be your fixed assets. These cannot be converted to cash within a year. They will consist of your property, furniture and fixtures, equipment, automobiles, etc. These accounts will have a debit balance. There will be an accumulated depreciation account associated with these accounts that will have a credit balance.
If you have paid any security deposits it may listed under Other Assets on the Balance Sheet.
Your liabilities are what you owe to other companies. A current liability will be paid off within a year. Your current liabilities will be accounts payable, and all your credit card accounts. These accounts should have a credit balance. If an account has a debit balance you may want to investigate the reason. For example, a credit card account may show a debit balance which would indicate that you have a credit due to you from them.
If you have employees, your other current liabilities will be payroll liabilities. Depending on the number of employees and the benefits you offer your employees, you may have several liabilities, or you may have just the payroll tax liabilities. Whatever liabilities you have, they should have a credit balance. If a liability has a debit balance, then you have probably over paid and are due a refund.
Your long-term liabilities are the debts that will not be paid off within a year. They will be your mortgage payment, loan payments, vehicle payments,etc. These liabilities will also have a credit balance.
This is the last section of your balance sheet and it shows how much money has been invested in your company. Depending on the type of entity, you may have an Owner’s Equity account, Capital Stock, or Treasury Stock account. Your retained earnings account shows what your company has earned since the beginning of it’s operation. Your retained earnings should be a credit if your company has been making money. If your company has not been making money it will be a debit balance. Dividends paid to shareholders, and draws to owners and partners will have a credit balance.
In summary, your balance sheet is a snapshot of your company’s financial position at a single point in time. The purpose is to give the users an idea of the company’s financial position along with what it owns and owes. It is very important that you understand how to analyze and read this document.”
So how can you make this simple to understand? Jo Ellen Peters shares a great article that describes some simple steps: http://ow.ly/OobFy