The 1-2-3's of Reading a Balance Sheet

When you run a small business you need to keep track of its performance. One of the tools that you will need to use in order to track the performance of your business is a balance sheet. A balance sheet is basically a snapshot of your company's financial position. It is not a projection and it is not a trend tracker. Instead it tells you what assets, liabilities and stakeholder investments the company holds on a specific date, e.g. today, a date one month ago or a day one year ago. Knowing how to read a balance sheet will help you to better understand your company and its financial condition.

Section 1: Assets

The first section of the balance sheet is the assets section. This section will be divided between two types of assets: current assets and non-current assets. Current assets include your liquid assets. This means that your first entry in this section will be the company's cash, which usually consists of the company's bank account(s). The balance that is shown under "cash" needs to be reconciled with the balance in the company's bank account(s). The second entry in this section is petty cash, which is the cash that you keep on hand for impromptu expenditures. The balance related to petty cash needs to match the amount of money you keep on hand. The remaining entries under current assets will include things like inventories, prepaid expenses and accounts receivable.

The second sub-section is non-current assets. This part of the balance sheet is your less liquid assets. The entries in this sub-section include property, equipment, intangible assets, investments and financial assets.

Section 2: Liabilities

The second section of the balance sheet summarizes the liabilities that the company owes. These liabilities are listed in order of their longevity, e.g. how long the liability is held. The first entry in this section is usually going to be accounts payable. The balance under this heading will need to equal your accounts payable balance to-date. Other entries in this section will include tax liabilities, long-term debt and unearned revenue.

Section 3: Equity

The final section on a balance sheet is the equity section. This section basically demonstrates what the owner or investors have contributed to the company's financial position. The headings under this section will include capital, reserves and non-controlling interest equity. For some small businesses, capital and reserves will be the only entry under this section.

Wrap-Up

The final component of reading a balance sheet is learning how to determine if the balance sheet is balanced. In order for it to be balanced the assets total needs to be equal to the equity total minus liabilities. The formula is: Assets = Liabilities + Equity.

Sources:

http://www.investopedia.com/articles/04/031004.asp