Periodically prepared balance sheets are the primary financial tool for assessing the relative wealth or financial condition at a given point in time. Learn what to monitor and track to ensure your business is growing.
This statement reveals your company's relative wealth or financial position at a given point in time. It's often referred to as a snapshot because it gives you a fairly clear picture of the business at that moment, but does not in itself reveal how the business arrived there or where it's going next. That's one reason why the balance sheet is not the whole story—you must also look at the information from each of the other financial statements (and at historical information as well) to get the most benefit from the data.
Along with other financial information, balance sheet data is frequently analyzed and put into perspective through the construction of business and financial ratios. In many cases, ratios are constructed for each balance sheet (and income statement) for a number of years, so that you can make comparisons and spot important trends.
The balance sheet consists of three categories of items:
- assets
- liabilities
- stockholders' or owners' equity
Assets
Assets are generally divided into two groups: current assets and fixed (long-term) assets. They are usually presented in order of liquidity, with current assets (cash and those that will be converted to cash within one year) appearing first.
| Assets | |
|---|---|
| Current Assets | |
| Cash | $ X |
| Short-term investments and marketable securities | $ X |
| Accounts and notes receivable | $ X |
| Inventories | $ X |
| Prepaid expenses | $ X |
| Other current assets | $ X |
| Total current assets | $ X |
| Fixed Assets | |
| Land | $ X |
| Buildings | $ X |
| Machinery and equipment | $ X |
| Capitalized leases | $ X |
| (Less accumulated depreciation and amortization) | $ X |
| Deferred charges | $ X |
| Other fixed assets | $ X |
| Total fixed assets | $ X |
Liabilities
Liabilities are normally presented in order of their claim on the company's assets (i.e., liabilities due within one year are presented before liabilities due several years from now).
| Liabilities | |
|---|---|
| Current Liabilities | |
| Accounts payable | $ X |
| Notes payable | $ X |
| Income taxes currently payable | $ X |
| Current portion of long-term debt | $ X |
| Other current liabilities | $ X |
| Total current liabilities | $ X |
| Long-Term Liabilities | |
| Long-term debt | $ X |
| Capital lease obligations | $ X |
| Deferred income taxes | $ X |
| Other long-term liabilities | $ X |
| Total long-term liabilities | $ X |
Equity
Stockholders' equity (or owner's equity or net worth) is presented properly when each class of ownership is presented with all its relevant information (for example, number of shares authorized, shares issued, shares outstanding, and par value). If retained earnings are restricted or appropriated, this also should be shown.
Stockholders' equity for an incorporated business normally would take this form:
| Stockholders' Equity: | |
|---|---|
| Preferred stock, $20 par value (authorized 1,000 shares; issued and outstanding 500 shares) | $ X |
| Common stock, $15 par value (authorized 10,000 shares; issued and outstanding 5,000 shares) | $ X |
| Additional paid-in capital, common stock | $ X |
| Retained earnings | $ X |
Using balance sheet data
You don't have to be an accountant to make effective use of the data on your balance sheet. Use balance sheet data to monitor your company's financial health by monitoring the following:
- Working capital: maintain a proper ratio of current assets to fixed assets.
- Cash levels: maintain only as much cash as needed; invest the excess in short-term investments.
- Accounts receivable levels: monitor receivables levels to ensure customers are paying promptly and providing cash flow to your business.
- Inventory levels: keep inventory as low as is reasonable for your business since the carrying costs associated with inventories are so high.
- Fixed assets: analyze your property, plant and equipment to see that these capital assets are being fully utilized and financed efficiently.
- Accounts payable: keep an eye on accounts payable to make sure the company has enough liquidity to pay its bills.
- Long-term debt: watch the debt-to-equity ratio and keep it in line with, or better than, industry norms.
Improving your balance sheet and using income statements
Although you can take steps just prior to the balance sheet date(generally, year-end) to improve it, you should be aware of how youractions and decisions throughout the year affect the "balance sheetappearance" of your company that may be presented to outsiders.
Often, the individual balance sheet items can be improved to give abetter-looking overall picture. For instance, you can improve cashbalances by retaining cash collected on receivables until after thebalance sheet date, rather than promptly spending the money.
Another area to watch, if you manufacture goods, is inventory. Sincefinished goods are more easily converted to cash than are raw materials,and also have a higher value, converting more raw materials to finishedgoods before the balance sheet date looks better when presented in thefinancial statements. Whatever your business, you may want to hold offon writing off receivables as uncollectable bad debts, or writing down marketable securities to reflect a decline in value (assuming the delays are justifiable).
Sometimes year-end planning to reduce taxes may be in conflict withyear-end planning to improve financial statements. This is becausehigher income looks good on your financial statements, but can cause youto pay more income tax. In such a case, you may have to choose betweenpaying higher taxes to make your company's financial statements lookbetter, or foregoing improved statements to reduce taxes. Depending onthe business and its needs, lower tax payments are not always your bestchoice.
Tip: The fact that a business owner can take steps to improve the balancesheet's appearance illustrates one of the shortcomings of the statement.To the extent that it can be manipulated, it becomes less reliable as an indication of a business's true financial condition.
If you are ever in the position of considering whether to buy orinvest in another business, you can already see why it's worth lookingbeyond the balance sheet.
Besides improving the individual items shown on your balance sheet, you can also improve its appearance by improving your business ratios (or the relationship between certain items). To illustrate how you can do this, consider four key business ratios derived from balance sheetfigures:
- two deal with the liquidity of the business (current ratio and quick ratio)
- two deal with the management of business debt (debt-to-equity and debt-to-assets ratios)
Working with income statements
While the balance sheet is a financial snapshot, giving you a pictureof the business's assets and liabilities on a single day at the end ofthe accounting period, the income statement shows you a summary of theflow of transactions your business has had over the entire accountingperiod. In other words, the income statement shows you what happenedduring the period between balance sheets.
The income statement, also referred to as a "profit and lossstatement," "statement of incomes and losses," or "report of earnings,"tells you or your investors:
- the income the business has earned in the accounting period
- the costs or expenses that were incurred by the business during the period
- your net profit — the difference between the costs and income for the period
Three years' worth of income-statement data is normally presented,so that you can make comparisons and identify trends. The data consistsof the following types of items:
- sales revenue
- sales returns and allowances
- other income
- cost of goods sold
- selling, general, and administrative expenses
- depreciation and amortization expenses
- interest expense
- income taxes.
