And can it offer me the work/ life balance I need to be a successful entrepreneur?
The balancing act
Let’s recap: it’s Friday afternoon, you’re prepared for a long-awaited evening picture show with your family, and the biggest order of your life is going to be processed by your team over the weekend. Then, your printing machine breaks. Parts are available, but they will cost double the price to ship them over the weekend. Can you afford the cost, and how does the balance sheet provide you with an answer?
The balance sheet it a magical thing. With a few pieces of information from this report, we can make informed financial decisions during a crisis and still make it in time for the movie. In this article, we will discuss what the balance sheet is, the puzzle pieces that form it, and then apply it to our emergency.
What is a balance sheet?
The balance sheet is a picture of how much your company owns [asset] today, and how much of your company is obligated by debt [liability versus equity]. The image of this perfect relationship comes alive in the following formula:
ASSETS = LIABILITIES + EQUITY
Why is it called a balance sheet? A great question with a simple answer. The value of assets that you own can only be split between two primary #’s; either you financed the asset with a mortgage or note [liability], or you own it outright [equity]. Therefore, the total value of assets must equal the sum of the liabilities and equity. If this is the case, then your balance sheet “balances.” If it does not, then we call it an “out of balance” balance sheet.
Why is the balance sheet important?
Every entrepreneur must keep a careful eye on how much money they have every day. Especially in the beginning. Remember, cash flow remains the #1 cause of small business failure to date.
[Assets] The asset section tells us exactly that; cash is the money in your bank account and accounts receivable are assets promised to you but not yet collected. These assets are considered liquid because you should be able to access them within hours to days. If one of your printing machines breaks you now have a crisis on your hands. Cash is the only thing that will solve this problem, and the balance sheet tells you how much have available to spend on such a crisis.
[Liabilities] Now that you know how much liquid cash you have, do you know how much is already promised away in loan payments, bill payments, and interest? Liabilities now enter the picture. Liabilities are just that: they are the amount of money you owe in short- or long-term loans. Accounts payable details the total bills due in the next 30 days. This would include utility bills, salaries payable, or supply and inventory purchases.
[Equity] The remaining balance of assets, after subtracting away liabilities, is the equity. This is the TRUE VALUE of what you own if you were to sell out today. It is the portion of your assets that no one can take away from you. When the bank asks you how much you are worth, net worth, you use this number in your calculation.
How to Calculate the Balance Sheet Formula:
ASSETS = LIABILITIES + EQUITY
Let’s put this all together and make it work using an easy to understand example: Barklee, Inc., your company, owns a warehouse, the land it sits on, and all the inventory in it. The building is worth $400,000, the land is worth $50,000, and the inventory is worth $1,000. You owe a mortgage on the warehouse and land of $250,000, and your inventory supplier allows you 30 days to pay your bill. Finally, you have $10,000 cash in the bank.
[Assets] If assets are everything that your company owns, then your balance sheet would look like this,
- Cash $10,000
- Inventory $1,000
- Building $400,000
- Land $50,000
Now, add them up: $461,000. These 4 items are what you own. The liquid portion is the cash, $10,000. If you have an emergency, you might be able to use that cash if it is not already promised to someone else. The inventory could be considered liquid if you can sell it, and collect on it, within 30 days. The building and land are considered fixed assets because they are not going anywhere any time soon.
[Liabilities] Now that we see how much our company owns, we need to know how much we owe on the mortgage and supplies. This would be considered a liability, and it would take away from our actual ownership in the case of a sale.
- Accounts Payable $1,000
- Current Notes Payable: $8,333
- Long Term Notes Payable $241,667
Let’s do the math: $251,000 in liabilities. When we subtract that value from the assets, we have $210,000 remaining. If we sold all of our assets today in a company sale then we would pay the bank and supplier $251,000, and then have $210,000 to do whatever we want.
Remember, if you owe a mortgage on a building then part of that mortgage is due every month. The current notes payable will help you to see how much is due in the immediate 12 months. So, divide this # by 12 and you know how much is due next month, or any month.
[Equity] We already know this number thanks to our formula [assets = liabilities + equity]:
- $461,000 = $261,000 + $210,000
The equity is your interest in the company. It is also akin to how much your company might be worth to a potential buyer who was interested in the assets.
Finally, let’s solve our crisis:
Our printing machine has quit working on us. We need to fix it immediately or we cannot fulfill our orders. No fulfillment means no income, and that would tank a brand-new entrepreneur for sure. I am going to build the entire balance sheet for you so that you can see the imagery for yourself.
|Current Notes Payable||$8,333|
|Long Term Notes Payable||$$241,667|
|Total Liabilities + Equity||$461,000|
The balance sheet balances. The liabilities tell us just how much of our liquid cash is already promised to our lenders; $1,000 is owed on account to the supplier within 30 days, and $694.42 ($8,333/ 12 months) is owed on the mortgage monthly. Therefore, we will spend at least $1,694.42 this month on loans. This does not consider your monthly expenses (see budgeting to factor in those numbers). Can we spend another $1,000 on our machine, solve our crisis, and not create a future cash crisis for next month? It looks like we can, $10,000 cash – $1,694.41 = $8,305.58 leftover. How many months can we cover our obligations with the remaining cash that we have?
The balance sheet rocks. At least in my opinion. If you are using a quality online accounting solution like QuickBooks Online, then this report is created in an instant. Every business owner should be printing the report every month, immediately after reconciliation. When combined with the other 3 primary financial reports any business owner can make a sound financial decision in the face of a crisis. Go get that machine fixed!
Want to learn more about the balance sheet, or learn about the remaining 3 financial statements? Sign up for alerts when we release new blogs. Our series this month is on the importance of the 4 primary financial statements that every entrepreneur should use.
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