Here at Virtual Bean Counters, we’re in the business of helping you not worry about financials – in fact – move beyond worry to understanding. Part of that education is knowing about different financial statements. Today we are going to focus on one of the basic ones: the balance sheet.
The balance sheet tells you three fundamental things: what you have (assets), what you owe (liabilities), and what’s left when you balance those (positive or negative equity). It’s a great “snapshot” of where your business is on a given day.
The first type of asset is a current asset. This can include cash in the bank, inventory, or other assets that can be liquidated or amortized within a given year of business. Most service based businesses invoice on terms for services performed, so they have “accounts receivable”, which also show up here.
Fixed assets, like current assets, have actual value, but are tangible assets needed to run the business and won’t be sold. This can include your computers, furniture, and even leasehold improvements. What’s great about fixed assets is that you can depreciate them over time and thus reduce your tax liability (and our eyes always light up when we hear about something that reduces our taxes).
That depreciation shows up right underneath the asset in question, for example:
Office Equipment: $15,000
Accum. Depreciation: -$8,200
Total Fixed Assets : $6,800
So we are moving from the exciting part of the balance sheet (what we have) to the less exciting part (what we owe). Because this is a snapshot it only shows what your business owes on a certain date, which can swing dramatically on different days of the month.
Current liabilities, like current assets, are in flux. They include lines items such as accounts payable (unpaid vendor bills), payroll liability accounts, and perhaps the balance on your line of credit with the bank.
Long-term liabilities would be anything that is going to be repaid beyond the scope of the business year. This might be a note payable to an investor/shareholder/owner or your term bank loan.
The “balance” in balance sheet happens when you subtract the liabilities from the assets, which reflects the net equity of your company. The actual balance formula is Assets = Liabilities + Equity, so the equity is the net of assets – liabilities. If that number is positive, then you have “equity” in your business. If that number is negative, you have “negative equity.” Keep things in perspective, though. Just because you have positive equity doesn’t mean you are in a position to sell your company or that it’s even saleable. And just because you have negative equity doesn’t mean your life is over. Many small businesses spend their first few years in negative equity.
Some of the most valuable parts (and the parts that are some of the most attractive to potential buyers) of your business sometimes aren’t even listed on your balance sheet. We refer to these as “intangible assets.” These include things like goodwill, intellectual property, and documented processes and systems.
Goodwill is what you’ve built up in the community throughout the time you’ve been in business. In the social media age this could be great reviews on Yelp, Google Places, or Tripadvisor, among other places. It includes relationships with vendors, customers (past and present), and employees. You can’t buy it. You can only earn it. That’s why it’s so valuable it can’t even be quantified on the balance sheet.
Intellectual property will vary from business to business – but if you don’t have some fancy invention that you use or sell, it can simply be way (systems) you do business or your trade secrets. That’s “intellectual property” too – even if you didn’t hire a lawyer to copyright it or put a trademark on it.
Systems are perhaps the most important intangible, and a big part of our thinking here at VBC. Systems, and systems alone, make your business functional and saleable. When you have systems in place you don’t have to depend on the owner or that “one great employee” (who please, please can’t ever be sick). Systems could be as simple as an actual and well-thought out job description for every person in the office, both current and future, or as complex as how a sale is completed product, from start to finish. A system means that the owner has thought through (and written down) every aspect of his/her business, but it also means a buyer could easily pick up those systems and run the business too.
A business’ balance sheet is basic in what it shows you, but it basically shows you your business health. Ignore it at your peril.