Running a business without looking and monitoring the Balance Sheet and Income statement is like running a race without knowing where you are going, but hoping that you are running in the right direction. Selling the product or service is not enough to keep the business alive. Without constant monitoring of the revenues and expenses, a business can easily fall behind and run out of money. The business can be doing really well with sales higher than ever, yet still have trouble keeping the doors open. Every business, small or large, needs to know what is going on behind the scenes. Most business owners tend to perceive financial statements to be very hard to read and understand; however, reading the financial statements does not always need to be so complicated. Here are a few basic tips:
Always start with the Balance Sheet. Think of the Balance Sheet as a tool to test or observe the health of the business. Start with the first category, Assets. It will always begin with the most liquid assets. Most often cash, which is typically what you have in the bank and petty cash, is listed first on a Balance Sheet. Knowing how much cash there is on hand is always very important for cash flow purposes. Commonly, the second item is Accounts Receivable. Accounts Receivable holds all the money that a business owner has invoiced the customer, but not yet received. If this particular item is not being handled very well and if the balance on this account is very high, business often will suffer cash flow issues.
The next category to look at is the Current liabilities, this would mainly consist of Accounts Payable or any Notes Payable due within the next 12 months. This shows how much business owes to creditors, bankers and vendors. Business owners should always try to keep their asset balance higher than their liability balance. A healthy company will make sure that they have a positive Stockholder’s Equity by making sure their assets are higher than their liabilities.
Quick and short illustration of the Balance sheet:
Bob barrows $100,000 from bank (Liability). He invests $50,000 buying a taxi cab (Asset) and the other $50,000 is cash deposited in the bank (Asset). Bob’s Balance Sheet is in balance. Bob makes $25,000 in profits in the first month and pays off $10,000 in principle to the bank. Below is Bob’s Balance Sheet:
In my next blog, I will walk through the importance of the Income Statement within the financial statements.
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