According to Bob Sloan, S3 founder, there are many tools available to business owners, seeking to understand and control their corporate finances. For new business owners, it is imperative to make use of all of these tools, but also to ensure a total understanding of them. One of the most important tools of all is the balance sheet, which is a gateway into full financial understanding and strategic planning. Sadly, the balance sheet is also one of the most oft-misunderstood tools in the business owners’ toolbox.
What is a balance sheet? For what is it used? How can one master the terminology and the layout of a balance sheet? Bob Sloan, S3 founder, offers his expertise in the paragraphs that follow.
Bob Sloan, S3 Founder: What is a Balance Sheet?
The best place to begin, according to Bob Sloan, S3 founder, is with a quick definition. A balance sheet, also called a Statement of Financial Position, is meant to provide a snapshot of the company’s financial state. Usually, this snapshot occurs sometime just after the end of an accounting cycle, or a major financial milestone in the life of the company.
A balance sheet captures:
- Assets (the things that the company owns)
- Liabilities (the things that a company owes)
- Net assets (assets minus liabilities)
Bob Sloan, S3 founder, says the importance of the balance sheet is difficult to overstate. When taken alongside the income statement and the cash flow projection, it provides a cornerstone of financial understanding. As such, no business owner should be unclear on how to read a balance sheet.
Understanding the Terminology
On one hand, it is not so difficult to understand a balance sheet. Bob Sloan, S3 founder, says the key is to ensure that the liabilities and assets balance out, and that the liabilities never surpass the assets. Beyond that, things can be a little murky, at least for the beginner. This is simply because there is so much financial terminology to keep in mind.
One term to note is the term current, which has a special meaning in the world of accounting. When it comes to the balance sheet, something that is current refers to a transaction that can be completed within the span of a fiscal year. Non-current items have longer lifespans.
Some further clarifications are in order. Consider the following terms:
- Assets. Anything described as a current asset is either cash, in a bank account or a petty cash drawer, or else something that can be easily and fairly quickly converted into cash. Account receivables include those short-term obligations that are owed to your company, such as sales or credits from customers. Inventory is a category that includes raw materials, finished goods, and products that are still works-in-progress. Finally, there are non-current assets, which are the ones that cannot be easily converted to cash, or that have long lifespans—buildings, land, machinery, computers, and so on.
- Liabilities. The Liabilities column includes any financial obligation that your company owes to others. Current liabilities are those that the company must pay within the fiscal year. These might include amounts owed to vendors and suppliers, as well as short-term loans. There may also be some non-current liabilities on the balance sheet, which are those that do not need to be paid within the next year.
- Owners’ equity. This is sometimes presented as a third category on the balance sheet, and sometimes it is just lumped in with liabilities. Owners’ equity represents the difference between total assets and total liabilities—what would be left, in other words, were all accounts to be settled, all debts paid, and all assets sold.
- Depreciation. Those who are using a balance sheet also need to be aware of depreciation. This is basically an accounting mechanism that allows you to spread the cost of an asset over the total years of ownership. This can prove helpful in determining the true current value of an asset.
Using the Balance Sheet
Knowing these terms is important, but what ultimately matters most is the understanding of just how the balance sheet can be used. The balance sheet is a form of record-keeping that rolls from one year to the next and allows you to see your company’s lifetime result—that is, the total accumulated surplus or deficit. The day-to-day operations of your company will affect this surplus or deficit. The surplus you have this year will cause the total surplus to go up; this year’s liabilities will reduce it, or lead to a deficit.
There are many practical implications. The balance sheet can help you to decide whether your company can expand or make a large financial investment. It can also reveal whether you need to take action to boost cash flow. Bob Sloan, S3 founder and managing partner, encourages business owners to spend some time absorbing their balance sheets.