Balance Sheet: How to Read this Important Document
This is one of three key financial statements that give you an overview of your business as it currently stands and informs every new decision you make for the future of your company:
This is a snapshot. The balance sheet only records your company’s assets and liabilities at a given point in time. Three categories are included in the balance sheet: assets, liabilities, and owner’s equity. Assets include cash, inventory, real estate, fixed assets with depreciation such as equipment, and any other investment with value that your business holds. Liabilities include short and long-term debts, deferred taxes, and depreciation on fixed assets. Owner’s Equity includes initial investment, retained earnings, and long term liabilities.
A = L + E
Cash = Loan + Retained Earnings example:
You take out a $100 loan from the bank, increasing liabilities by $100, increasing assets (in cash) by $100.
You use your $100 in cash to make $100 worth of products (cash converts to current assets), then sell your $100 worth of products for $200. You repay $100 to the bank for the original loan. First, that increases assets to $200, and increases owner’s equity $100 (retained earnings). Then, you repay the loan decreasing assets (cash)$100 and decreasing liabilities (loan) $100.
Your balance sheet changes three times over the course of your doing business in this simple example:
- A$100 = L$100 +E$0
- A$200 = L$100 +E$100
- A$100 = L$0 + E$100
Understanding where your business is in its financial cycle can directly impact decisions regarding whether to take out an additional loan, repay a loan, develop additional inventory, or reinvest equity into the business.