A sound financial strategy is the foundation for a successful business venture, and for this reason we’ve created a series about the different aspects of building a financial plan. This week’s topic: the balance sheet.
What is a Balance Sheet?
A balance sheet is one of the three primary financial statements, which can be used to assess the financial condition of a business. The primary function of the balance sheet is to showcase the financial stability of the company at a point of time. An analogy can help illuminate the role of the balance sheet and the two other primary financial statements: imagine a mountain lake. The lake is fed by a stream flowing in and emptied by a stream flowing out. The streams represent the income statement as it monitors the inflows and outflows, while the lake represents the balance sheet as it monitors the pools of accumulated capital, and the cash flow statement measures the changes in the total water level.
How Does It Work?
Basically, the balance sheet displays the monetary value of everything that your business owns (your “assets”), what it owes (your “liabilities”) and the accumulated difference between the two (your “equity”). One extreme way of thinking about the balance sheet is to ask: if we shut down the business today and sold everything from the machines, to the inventory, the desks, etc. and used that money to pay everyone to whom we had an obligation, what would be left? Creditors thus use the balance sheet as one important element in evaluating the safety of providing a loan.
The balance sheet basically is comprised of two columns. The first column includes the value of assets, which means, the value of everything your business owns. This will include the cash you have in hand, your current inventory, your machinery and so on. On the other side, you will place all your liabilities. This will include your payables, any loans that you have outstanding and so on. Finally, the second column also contains your equity section, which is the accumulated investment in, and earnings of the company.
The balance sheet is valuable to the business owner and to creditors or other business stakeholders because it provides a snapshot of these important pools of capital – your assets, liabilities and equity.