How to understand your balance sheet: A beginner’s guide
A balance sheet is a financial statement that provides an overview of the company’s assets, liabilities, and equity at a specific point in time. It is important to know what each one means in order to understand how well you’re doing. It can be difficult to understand all the information on this document, but there are ways to break it down into more manageable pieces.
What is a balance sheet?
The balance sheet is a financial statement that provides information about the assets, liabilities, and equity of a company.
The first section of the balance sheet lists the assets on hand. Assets are anything that can be turned into cash. Assets include cash, accounts receivable (money owed to you), inventory (goods waiting to be sold), and prepaid expenses (e.g., insurance that is paid annually in advance). Assets are usually broken up into short-term (less than one year) and long-term (one year and longer)
The second part lists liabilities, which are things you owe money for. Liabilities include loans payable or due for goods purchased on credit. Like assets, liabilities are usually broken up into short-term and long-term.
Finally, equity is calculated by subtracting what you owe from what you own. This is also referred to as net worth or the net value of the business.
The importance of the balance sheet
Balance sheets are a snapshot of what a company’s assets, liabilities, and equity look like at any given point in time. A balance sheet is a tool that can be used to find out if a company has enough money to cover its obligations and stay afloat or enough assets to cover its long term obligations.
The balance sheet can also be used to determine how a company is financing its operations. A company that is generating enough net income will have higher retained earnings from one year to the next. A company that is financed through debt will have an increase in long-term liabilities year-over-year.
How to read a balance sheet
Below is an example of a balance sheet.
We already explained assets, liabilities, and stockholder’s equity. The balance sheet must always “balance” because assets equal liabilities plus equity (known as the accounting equation). Understanding this equation helps you understand a company’s position. If the company has more liabilities than assets, then it will have negative equity, which is a potential major red flag especially with mature businesses.
Investors and creditors like to determine a company’s financial health using something called ratio analysis. To determine how liquid a company is, divide current assets by current liabilities. In the example above, 67,500 / 34,200 = 1.92. Whether that is good or bad depends on the industry. In general, anything near or over 2.00 is acceptable.
Other performance indicators include solvency ratios (also called financial leverage ratios), profitability ratios, efficiency ratios, and coverage ratios. Corporations also have market prospect ratios which are used to predict performance, which is imperative when valuing a company’s stock price.
How to use information from the balance sheet to improve your finances
Did you know the information found on a balance sheet can also be used to measure your company’s vulnerability to risk? A complete balance sheet includes key pieces of information like cash on hand, accounts receivable and inventory. By analyzing these numbers, you will be able to see where your business is strong or weak in relation to other companies in similar industries. If there are any areas for improvement (i.e., too much debt), it will allow you time to prepare so that when the unexpected happens.
If you want to take control of your finances and improve them, the balance sheet is a good place to start. Understanding what it includes and how to read one will provide insight into where you can make changes in order to get more money for yourself or avoid unnecessary expenses that are taking too much from your paycheck.
The best way to use this information is by comparing two different months side-by-side on paper so that you have everything at hand. Once you have done this, focus on adjusting only those areas which seem most important – like lowering debt payments or reducing inventory on hand – and see if there is an impact in your bottom line!
The balance sheet is a powerful financial tool that can be used to improve your finances. It’s important for you to understand how the information on the balance sheet works and what it means in order to make informed decisions about improving your money management skills. Let us know if we can help! Contact our team of experts today and let them show you how they have helped others grow their wealth with remarkably simple math.