Balance Sheet Article

The Balance Sheet – A Valuable Yet Overlooked Financial

Often, businesses concentrate on their Income Statement and Cash Flow Statement without much consideration to the Balance Sheet.  This is a mistake!  The Balance sheet is important because it:

• Illustrates the effect of past decisions
• Keeps track of the business’ cash position liquidity
• Records what the Owners’ Equity position is at different time intervals
• Directly affected by the Cash Flow and Income Statements, which reflect the status of the company’s operation
• Quickly shows the Condition of a Business

Note: Scroll down to the end of the article for a Sample Balance Sheet

The Balance Sheet illustrates how a Company’s Assets, Liabilities and Net Worth are distributed at a given point of time or time period.  The Balance Sheets’ set format facilitates analysis.  The order of the Balance Sheet’s itemized categories is arranged in the order of Decreasing Liquidity and Immediacy for Assets and Liabilities respectively.  Because the Balance Sheet shows changes in Debt, Net Worth and the Business’ Condition over time, it is an excellent tracking and control document.  Before getting into Balance Sheet Analysis, let’s examine the important major sections of the Balance Sheet (please find the Balance Sheet format as an Appendix at the end of this article).

• Current Assets:  Cash, Government and Marketable Securities, Notes Receivable, Accounts Receivable, Inventories and Prepaid Expenses.  Any other item that can be converted to Cash within one year.
• Fixed Assets:  Land, Plant, Equipment, Leasehold Improvements.  Other items that are expected to have a useful business life which can be measured in years. Depreciation applied to items that wear out.
• Other Assets:  Intangibles such as Copyrights, Patents, Contract Exclusivity and Notes Receivable from Company Employees and Officers.
• Current Liabilities:  Accounts and Notes Payable; Expenses that Accrue (such as Wages, Salaries, Withholding, FICA); Taxes Payable; Current part of Long Term Debt; and other Obligations coming due within a year.
• Long Term Liabilities:  Trust Deeds, Mortgages, Equipment Loans and Long Term Bank Loans.  All of these are Net of current part of Long Term Debt (appears as a Current Liability).
• Net Worth:  Assets minus Liabilities.
• Owners Equity:  Principals Equity Stake, Retained Earnings and other Equity.

Balance Sheet Analysis

Three ways to quickly determine the health of your business:

1)     Analyze Working Capital:  Subtract Current Liabilities from Current Assets to determine your Working Capital level.  Cash is only part of Working Capital.

a)     Illiquid Businesses can have a hard time securing future loans.  Solutions are Working Capital Loans, Fixed Asset Sale, Financing Accounts Payable or Securing New Equity Investment.

Resource:  For comprehensive information on Business Funding, please refer to the ABC Business Consulting Business Finance Section in its Business Success Articles.

2)     Compare Fixed Period Balance Sheets:  By comparing similar periods of time, you can quickly spot Trends and Weak Areas, which upon investigation you can determine, the reasons driving them.  If you are an established Company, compare yearend Balance Sheets.  If a new company, compare Balance Sheets from one quarter to the next.  Upon analysis, problem areas and strong areas jump right off the paper!

3)     Current and Acid Test Ratios:  These analyses are percentage verses dollars based so it is easy to compare against industry and area norms of similar companies.

a)     Current Ratio:  Measures a Company’s Liquidity or its ability to meet current obligations in the next year.

i. Formula:  Current Assets ÷ Current Liabilities

ii. In order for the analysis to mean anything it is important to understand what is represented by this ratio.  Factors affecting the Current Ration are Type of Inventory, Quality of Receivables, Sales Cycle Timing, Time of Year, etc.  2.0 typically represents a healthy company.

b)    Acid Test:  The “Quick Ratio” is calculated by Dividing a Company’s Most Liquid Assets by Current Liabilities.  Liquid Assets include Cash, Securities and Current Accounts Receivable.  1.0 typically represents a healthy company.

Note:  2.0 Current Ratio and 1.0 Acid Test (Quick Ratio) benchmarks are non-industry specific.  Be sure to investigate the healthy levels for companies closely resembling yours.  Trade Associations, Banks and Dun & Bradstreet are good sources of ratio comparative information.

Footnotes:  Footnotes of assumptions and calculations are very important for a 3^rd Party reader, such as a Banker.  A Bank would be interested in how restricted your Assets are, so an explanation for each Asset item would be in order.  An investor would be very interested in the details of Owners Equity.  A Banker would also be interested in a breakdown of Accounts Payable, detailing exactly when liabilities come due.

Resource:  For extensive information on Balance sheets and details on Financial Ratios, please refer to the ABC Business Consulting Book:  The Comprehensive Business Plan Workbook – A Step by Step Guide to Effective Business Planning.

Appendix

Example Balance Sheet Format

Assets

Current Assets

Fixed Assets

• (Less) Accumulated Depreciation
• Net Fixed Assets

Other Assets

TOTAL Assets

Liabilities

Current Liabilities

Long-Term Liabilities

TOTAL Liabilities

NET Worth / Owners Equity

Total Liabilities & Net Worth