Balance sheets show your financial position
A balance sheet is divided in three parts:
- assets
- liabilities
- equity.
Balance sheets show what your business’s financial position is at a moment in time. You want these three parts to balance, so the final result is zero.
Master your balance sheets and cash flow statements
Transcript
The first step to understanding your finances, is looking at the balance sheet and the cash flow statement.
A balance sheet is a snapshot of your business's financial position at a particular time. It is divided into three parts: assets, liabilities and equity.
Assets are the items which add value to your business. Your balance sheet will show you what each asset is worth.
Liabilities are money you owe or need to pay back to your lenders.
Equity is the net worth of your business. It's the difference between the sum of your assets and the sum of your liabilities. If your equity is positive, it means that your liabilities are smaller than your total assets. If your equity is negative though, it means that your total liabilities or debts are greater than the total sum of your assets.
The question is, why is it called a balance sheet? What exactly is balancing here? Well, the idea here is that the total assets balance the total liabilities, plus the equity.
A cash flow statement is a summary of the cash transactions of your business, over a certain period of time. It is kind of like checking your bank balance, but better. Because it allows you to identify patterns and problems.
A cash flow statement is divided into five parts:
- cashflow from operations
- cashflow from investing
- cashflow from financing
- closing cash balance
- net change in cash.
After looking at these two statements, you should be able to understand the financial position of your business, at any given time.
You'll be able to spot opportunities and risks. You'll be able to identify what you have and what you owe. And you will be able to communicate this information to lenders and investors.
For more information on balance sheets and cash flow, head to business.govt.nz
Assets
Assets are things your business owns. They are the tools of your trade which help you do your business – for example a van for a delivery company, a secret recipe for your house cocktail, or a written agreement with a supplier.
Your balance sheet shows what each asset is worth, which is important if you want to raise money or sell your business.
These types of assets are common on a balance sheet.
Current assets
These are items expected to convert into cash within 12 months, including:
- inventory – what you sell to make money for your business
- accounts receivable – money you’ll get in the near-future by customers paying on credit.
Inventories are the result of cost of goods sold, which are also listed on your profit and loss statement – for example bread for sale at a bakery.
Fixed assets
These are items expected to last longer than a year – for example, land or equipment. These are not for sale, and they are depreciated in value over time.
Intangible assets
These are ideas, practices or agreements you have bought from someone else, including:
- intellectual property
- goodwill – value added to a business by assets that can’t be itemised.
Prepaid expenses
This is money you’ve paid in advance for goods or services to help run your business. It’s an asset because your business will receive value from it in the near future.
Capital expenditure
This is an accounting term to track money invested in current or fixed assets, also known as capex. When buying a new asset or upgrading an existing one – for example a vehicle or laptop – the money will be counted as capex and it shows up on the cash flow statement as a capital expense.
Financial assets
These are either:
- investments in other businesses – for examples shares or bonds
- assets that are not part of your regular business activities – for example, a tech company buying a vacant lot to sell in a few years to make money.
When you buy or sell long-term assets, they also show up on the cash flow statement under cash flow from investing.
Your bank balance is also an asset on your balance sheet. This cash also appears on your cash flow statement under opening or closing balance.
Decreases in non-cash assets show up in the cash flow statements as positive because cash has been received. The cash line will change, but total assets will remain the same on the balance sheet.
Liabilities
Liabilities are money you owe or will have to pay in the future.
Tracking liabilities in a balance sheet allows you to know the cost of running your business and your future bills.
These types of liabilities are common on a balance sheet.
Current liabilities
These are what you’ll have to pay out within a year, including:
- income tax
- salaries
- unused employee leave or holiday pay
- bonuses for employees likely to hit agreed targets
- loan or mortgage instalments for next 12 months
- unearned, or deferred, revenue – pre-paid orders and other money you are been paid in advance.
Items such as accounts payable, accrued wages and unearned revenue are also listed on your cash flow statement as a non-cash liability. Paying them off means a decrease in your non-cash liabilities as well as your cash assets.
When you pay income tax, it shows up on the cash flow statement under operating cash flows, and on the profit and loss statement.
Unearned revenue is a liability because you haven’t yet done what you’ve been paid to do, and costs linked to supplying it haven’t yet come out of your pocket. Once the sale is completed, the amount paid is no longer a liability: it’s recorded as revenue on your income statement.
Checking deferred revenue will:
- help you manage cash flow
- show potential buyers or investors a fuller picture of your business’s earning potential and sales to be completed.
Accounts payable
This is money your business owes for goods or services – for example to a vendor or supplier.
Keep track of these figures to plan your spending, make sure bills are paid, and keep an accurate idea of costs for each job or project. Potential buyers or investors will look at accounts payable to see if your finances are under control.
Non-current liabilities
This is money you’ll have to pay out over a number of years, also known as a long-term liability. It includes the following:
- Long-term debt: total amount borrowed minus payments for the next 12 months – these are a current liability.
- Long-term leases: total amount borrowed minus payments for the next 12 months – these are a current liability.
Equity
Equity is the net value of your business. It measures the accumulated money in your business, including money from you or an investor. Positive equity means your assets are worth more than your liabilities. Negative equity means your liabilities outweigh your assets.
For small to medium-sized businesses, equity might be retained earnings alone. For larger businesses, balance sheets tend to include shares and other types of equity. If you have business partners, or an investor who owns part of the business, this is where their stake will show up.
These types of equity are common on a balance sheet.
Retained earnings
This is the cash reserves your business has built up.
This is how it’s calculated:
Previous statement’s retained earnings + net income - dividends paid to shareholders = current retained earnings.
A positive number means you have money to invest back into your business or pay off debt faster. Negative retained earnings means your business has built up more losses than income over time. Fast-growing businesses might have negative retained earnings.
Retained earnings links to the profit and loss statement because it’s an accumulation of all years’ profits, minus any dividends paid.
Total shareholder equity
This is also known as net assets. It’s funds contributed by the owner and any others with a stake in the business, plus retained earnings.
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