WTH IS A BALANCE SHEET
Aright…part 2 of our Financial Statement dissection brings us to Balance Sheets. If you’re a sole prop, chances are you haven’t had to deal with the world of Balance Sheets, but if you’re a corp, Balance Sheets are financial staples. While income statements show your revenue & expenses, your balance sheet shows HOW that money came in and out of your business.
Three things make up your balance sheet – assets, liabilities, and equity. The “math” here is that Assets = Liabilities + Equity. And as you might guess, they have to “balance” ;P
ASSETS
Simply put, assets are the things you own. They’re what gives your business value. There are two kinds of assets that you might hear about Current Assets and Long-Term Assets.
Current Assets are the things you own that can “easily” be turned into cash:
Cash
Yeah that’s a little obvious, right? The ultimate “current asset” is the readily available cash in your chequing and savings accounts. If you’ve got bills to pay, this is your first source.
Accounts Receivable
The next best source of cash is the money owed to you from your clients/customers. You’ve done the work or delivered your service and it’s time for you to collect! Don’t get in the bad books with your suppliers just because your customers are behind on their payments.
Inventory
This one’s only relevant if you sell “things”; this is your third tier of quick-to-convert-to-cash assets. This not only includes ready-to-sell inventory but also your raw materials and packaging. If you were in a cash crunch you could sell off things in your inventory and turn it into quick cash to pay off some bills.
Inventory gets moved over to your income statement when you sell it; when it moves over its called Cost of Goods Sold (COGS). The idea is that you apply the expenses at the time that you actually sell it, instead of when you buy it. It is somewhat good in that if you spent 10K buying a bunch of inventory in December, but didn’t sell it till the next year, you’d have this giant expense one year, and a ton of revenue the next…your tax bill would be WAYYYY bigger because of the sales, with no expenses tied to them.
Ok you’re right – it’s accounting insanity but trust me…its good for you.
Some less common assets are prepaid expenses (think subscriptions or insurance that you pay one a year), security deposits, and loans that others owe to you (best kind of loan right?).
Long-Term Assets are things you own that hold their value longer than a year. There are the biggies, like land, buildings, and vehicles. And the more common ones like computers, furniture, tools, and equipment. Like inventory, we “expense” parts of it each year, so that we can spread the expense-love throughout the life of the “thing”; that expense is called Amortization or Depreciation.
LIABILITIES
Liabilities are things you OWE to others. Like with assets, there are current and long-term liabilities. Current are those debts that you generally pay within a year:
Credit cards
Accounts Payable – aka unpaid bills
Lines of Credit
Sales Tax – aka GST
Corporate Taxes
Vacation Pay
Long-Term liabilities are loans and mortgages, including shareholder loans. They’re debts that you’ll take longer than a year to pay off.
EQUITY
This is the last piece of the puzzle. Equity is the value that the shareholders have in the business; it’s the amount left over if you sold all your assets and paid all your liabilities. Spoiler…you want this to be a positive number ;) If it’s negative, unfortunately that means that if all your debts had to be paid, you didn’t have enough cash/assets to pay them all, and you had to cover it. Whomp Whomp.
In this section you’ll see:
Shares/Stocks – if you’re a corp
Retained Earnings – this is the money held over year over year from your business; it’s the running tally of your profitability or loss since day 1
Net Income – the current years’ profit; this is pulled from your Income Statement
Dividends – the amount you paid out to shareholders (most often this is to yourself!!)
So that’s WHAT everything is…now what should you actually look for in your Balance Sheet?!
Well first, you want to watch that your current assets are more that your current liabilities. Why? Well ideally you want to have the security to know that if all those debts were called in, you could cover them.
Similarly, will ALL your assets cover ALL your liabilities? Your ultimate goal is to watch these statements to ensure you don’t get stuck having to pay off the business’ debts out of your personal pocket.
I also like to watch:
Inventory
To make sure you’re not carrying too much product, and your turnover (i.e. how long it takes you to sell your inventory) isn’t too long. Not surprisingly, you don’t want to be sitting on a ton of inventory over time; the longer it takes to sell it off, the longer it takes for you to see a return (aka MONEY) out of that investment (which could have been your time, and/or your money).
A/R & A/P
Next week we’ll talk about A/R and A/P reports in more detail, but on the balance sheet, you want to watch that these don’t get too out of control…you don’t want to be living in the world of IOU’s – whether its you owing others (A/P) or others owing you (A/R).
Shareholder loan vs Profit and Debts
Are you spending all your companies money at the expense of being able to pay your businesses’ bills? If when you look at your balance sheet, and your shareholder loan is a NEGATIVE number, that means you owe your business money (i.e. you took the “loan”); if its POSITIVE, that means the business owes YOU money (i.e. you’ve put personal money into the business or used your personal credit card of bank accounts to pay for the businesses bills.
Having a negative SHL is normal – don’t freak out about that. For many solo-owned corps, this is how we pay ourselves (myself included!). What you want to “worry” about is when your SHL is huge while you’re A/P, credit card, line of credit, and loan debts are raging. If you’re using your business as your personal piggie bank – even if the business can’t afford it – you’re putting your business in financial jeopardy.
This is generally where the Budget-Police need to intervene and reign in the spending tsunami…potentially in your business, but most often, in your personal life. Head over to the ABOUT page….see where I say I’ve been called a “fun-vampire”? Its cause I’m usually the one playing the role of Officer Tucker – Budget Patrol, and having to tell people to stop having “fun” and spending money they don’t have….I suck the fun out of everything.
BUT…on the plus side, Officer Tucker definitely eliminates that cashflow anxiety and helps put an end to the sleepless nights and spontaneous stress-cries worrying about money. It’s a good trade off. Stress crying is the worst, and if I have to be the fun-sucking demon to get you there; I’m willing to take the fall.
[P.S. if stress-crying is part of your monthly (or weekly) routine…book a call with me for a free Get me out of this Chaos Heart-to-Heart; let’s see how we can get you out of this mess <3]