How to Read Your Balance Sheet Assets and Liabilities
One of the biggest mistakes we see among small businesses is relying on bank statements to monitor the financial health of the company. If you're only using your bank statements to monitor the money you have for your business, you're missing several key elements that affect your budget.
Managing company funds go beyond knowing how much cash you have in the bank and into a significant analysis of liabilities, equity, and assets. That's why keeping an accurate, up-to-date balance sheet is essential. When running a business, you must know what funds are going in, what's being paid out and the current value of everything you use in daily operations.
Balance Sheets Explained
A balance sheet gives an overview of your business’ assets and liabilities. Assets are everything your business owns. Liabilities are everything your business owes. What's left is the "book value" of your company, known as capital equity depending on whether you operate as a sole proprietor or as a corporation with stockholders.
When preparing a balance sheet, assets must be divided into different categories. The money made from sales (accounts receivable) is different from the value of inventory, and separating types of assets gives you a clearer idea of how much actual cash you have to work with. After all, $2 million in raw materials may be an asset, but you cannot leverage it to pay next month’s utility bills.
This category includes cash and cash equivalents such as money in bank accounts, certificates of deposit, bonds and other sources that can quickly be translated into cash without losing any value. Accounts receivable, a list of any payments or sales that are waiting to be settled, are also considered liquid assets. If you have any short-term investments that can be sold if need be, your balance sheet should reflect that as well.
Current assets are assets that will be converted into cash or used up within the next twelve months. Accounts receivable is the most common current asset. Other examples include short-term investments, inventory, and prepaid expenses.
Assets that are considered "fixed assets" include the land and buildings that your business owns as well as the equipment, machinery, and vehicles that you use on a regular basis. For example, if you run a restaurant that also offers a delivery service, your ovens, refrigerators, freezers, and delivery cars all count as fixed assets.
The category is used to keep track of non-liquid assets that are expected not to be converted to cash within the next twelve months. The most common example might be a security deposit in your office that the landlord will hold onto for the duration of the lease term. To determine your total assets, add your liquid, current, fixed assets and other assets together. It is the total value of every potential form of cash in your business.
Just like with assets, businesses have more than one kind of liability. These are also accounted for separately on your balance sheet so that you can see what you have to deal with now and what expenses will be coming up in the future.
Anything that you must pay within the next twelve months is considered a current liability. It may include accounts payable, which are outstanding balances to those who provide inventory and services to your company, and wages earned by employees that haven't yet been paid out. Monthly bills may also fall into this category.
If you have expenses or payments that go beyond the current year, these are listed as long-term liabilities. A mortgage balance is a common example of a long-term liability. Ongoing payments or monthly deliveries might also be long-term if you expect them to continue for more than 12 months.
The Importance of Reconciling
Of course, to know exactly how many assets and liabilities your business is dealing with, you have to reconcile your bank and credit card statements on a regular basis. Simply assuming that all of the transactions you've written down and those that have actually gone through are the same can get you into trouble when it comes time to pay bills or file taxes.
Reconciling your bank statements is essential to ensuring the security of your business funds. When you go through a monthly statement, check each transaction against your own register and make sure it matches. You may find payments or deposits that you forgot to write down; subtract or add these accordingly. Match all outgoing check numbers to your records to ensure that none are missing and, if any are, call the bank to verify those expenditures and update your register.
Making sure that your records match the banks helps you avoid large errors and maintain an accurate account of the money you have available. It's easy to make a mistake writing something down when you're in the middle of a hundred other things, and taking the time to reconcile your bank statement can save you from a big financial headache later on.
Going over your bank statements will also alert you to any fraud or theft. Unfortunately, this can be a not-so-uncommon problem when it comes to bookkeeping and maintaining a close watch on your regular account activity can help you identify incorrect or fraudulent charges before they start to add up.
Credit Card Statements
The money that your business pays out is just as important as the money that comes in. Look at your monthly credit card statement as soon as it arrives and keeps an eye out for duplicate charges or unauthorized purchases. If you come across any activity that seems suspicious, contact the company that issued the credit card and have it canceled immediately.
For legitimate purchases, make sure that all of the charges are correct. Accidental double-charging or a mistake in a quoted price can result in your company paying out more than it should to your suppliers. Resolve these problems as quickly as possible and double-check to ensure that you've accounted for all purchases made over the course of the month.
Once you've reconciled both statements, check the resulting amounts against your balance sheet and make any necessary changes so that they all match. The point in doing all of this each month is to prevent harmful losses and monitor how well you're handling business funds as a whole.
Having a comprehensive overview of your company's assets and liabilities makes it easy to see where money is going and how you can better manage expenses. Many small businesses start out with a deficit in the form of loans or lines of credit that need to be paid off over time to operate in the black. The better you understand your business finances, the easier it will be to find ways to bring your affairs into balance and reduce debt.
A properly managed balance sheet allows you to stay on top of every transaction that occurs during the daily operations of your business. It gives you something to show the bank if they need a record of your company's worth, assures current investors that your finances are under control, and can be a tool for raising additional investment capital.
As a business owner, an accurate balance sheet offers peace of mind in knowing that your finances are in order, and you have a clear picture of how much money is available to cover the expenses that inevitably arise when running your company.