What is a Balance Sheet and Why Is It Important for Business Owners?

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Balance sheets are meant to shows a company's assets, liabilities and shareholders' equity at a specific point in time. This information can be used to measure a company's financial health and performance.

What is a Balance Sheet?

A balance sheet is one of the three financial statements that business owners use to gain insights into their company's financial health. The other two statements are the income statement and the cash flow statement.

The balance sheet shows a company's assets, liabilities and shareholders' equity at a specific point in time.

• Assets are everything a company owns and can use to generate revenue. Think cash, vehicles, equipment, etc.
• Liabilities are everything a company owes to others. This includes accounts payable, loans and credit card debt.
• Shareholders' equity represents how much money every partner has added and taken from the business.

Why is the Balance Sheet Important?

Business owners use balance sheets to understand the value of their assets, how much they owe, and how much they’ve added to their business.

A balance sheet can also be used to assess a company's risk level and its ability to repay its debts, by analyzing outstanding liabilities and cash on hand.

Many business owners and investors will use the balance sheet to analyze ratios, such as the debt-to-equity ratio, which can provide a good sense for the operational efficiency of your business and the financial condition. The main ratios used by business are financial strength ratios and activity ratios.

Financial strength ratios, like working capital and debt-to-equity, will provide you with information on your company’s ability to meet it’s current obligations and how those obligations can be leveraged (i.e. using debt to your advantage).

Activity ratios focus mainly on current standings of accounts and how well your business manages its operating cycle. Days-In-Inventory and Days-In-Receivables are both ratios that show how long your inventory is sitting prior to being sold and how long it takes to get paid.

What are Some Things to Keep in Mind When Reading a Balance Sheet?

There are a few things to keep in mind when reading a balance sheet. First, all of the numbers should be reported as of the same date.

Second, all assets should be listed in order of liquidity, which is the order in which they can be converted into cash. While, Liabilities and Shareholders' Equity should be listed in order of seniority, which is the order in which they must be paid.

Finally, it is important to remember that a balance sheet is a snapshot in time. This means that it only shows information about a company's financial situation at a specific point in time.

If you're like most business owners, you probably don't have a lot of spare time to sit down and read through all three of your company's financial statements. But if you want to get a better understanding of your company's financial health, it is important to review all three statements on a regular basis.

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