It is found that a business owner or CEO will often bypass the business balance sheets in favor of the income statement and profit and loss statement. As the income and profit and loss statements are important and can help provide needed information of the business’ financial state, the balance sheet is another important document that requires equal amount of attention. Understanding as well as how to handle balance sheets is often misunderstood, which is why Mecham Dicus & Company would like to share how balance sheets have their place.
What is a Balance Sheet Used For?
Many business owners and CEOs will depend on the income statements as well as the profit and loss statements and are highly useful. However, they do not provide nearly as much detail as a balance sheet. Even with a quick glance, the numbers on a balance sheet provide a complete financial snapshot of the business at that current point in time. A balance sheet provides the company’s assets, liabilities, liquidity, and equity as it occurs. The income statement and profit and loss statement only provides a picture over a longer period of time. As having a balance sheet is essential, it is also important to know how to get the most out of your balance sheet. The balance sheet is a snapshot of the now and will not be the same tomorrow. You can look at two days balance sheets and see that can be different from one another. Over a span of two weeks, the balance sheet will greatly change because the account balances, payroll schedule, payable and receivables will change. This is what makes balance sheet hard to use for a number of business owners and CEOs. However, the balance sheet is all about comparison. With good comparison you will be able to unlock the balance sheet’s full potential. Following is how to use your balance sheet and what aspect you should focus on when reading a balance sheet.
Tracking Equity Trends
In a balance sheet there is a report of the businesses equity summary and culmination that occurred so far in your business. Over time it can help show the business how well it is managing the company’s value. The balance sheet distributed at the end of every period is best to track the company’s equity and its net worth. Equity is important as it is the first building block to a profitable business. All business financial successes start while Equity = Assets – Liabilities + Net Income. The balance sheet makes it easier to see if the company is growing or needs a development plan to ensure the business success.
Changes in Assets and Liabilities
A CEO or business owner will use the assets and liabilities to calculate the company’s equity. Once the equity has been calculated, then one can see assets, liabilities, and equity as individual components of the business. It is important to separate each into their own category as it can help reveal the company’s cash and where it goes at the end of each week, month, and year. A perfect example is when the balance sheet shows a problem with the business’s cash flow as the liability grows more quickly. It is important to monitor any changes in assets or cash flow as well as the liabilities on the spreadsheet to know where problems can be corrected.
Determine Liquidity through Current Ratio Calculations
A balance sheet will provide the current ratio or also known as “working capital ratio”. The ratio can help reveal the company’s liquidity or its ability to pay debt owned. A balance sheet can help show the best way to pay off short or long term loan or obligations. This is done by comparing all of the business’s liquid and illiquid assets to total the company’s liabilities. The ratio reveals more than just simple cash flow of the business when used correctly.