Have you ever looked at a balance sheet and wondered what to do with it? Yeah, the numbers on both “sides” add up, but now what? If looking at a balance sheet is like looking at a foreign language, then this week’s post is for you!
Previously, we discussed how important it is that you use financial reports as a roadmap for your business. This week, we’re going to take a deep dive into how to read a Balance Sheet, so that you know what you’re looking at. More importantly, I want you to know how to use the Balance Sheet to steer your business towards growth & profitability. Ready? Here we go!
What does a Balance Sheet tell you? The balance sheet is a snapshot of your business at a very specific time. It gives you a glimpse into what you own, like cash and inventory, and what you owe, like credit card debt and loan payments. Why is that important? Because you want your assets (what you own) to exceed your liabilities (what you owe) at any given time. We’ll go through the balance sheet screenshot below for Craig’s Design and Landscaping Services to help us walk you through a typical Balance Sheet.
Throughout this post, I’m going to refer to the Balance Sheet for Craig’s Design and Landscaping Services from QuickBooks Online, their Sample Company. (Did you know that you can test drive QBO?? Comment below if you’d like the link for this sample company account!)
Starting at the top of the Report, you should see a list of the assets owned by your business. Those assets will include the cash in your bank accounts, amounts owed to you by your clients (a.k.a. Accounts Receivable or A/R), and maybe some Inventory. If your business owns your laptop and printer, then you will see the purchase price of those items listed under Fixed Assets near the bottom of the Asset listing. All told, this list should reflect everything owned by your business.
These numbers are particularly helpful when you look at them in comparison to last month or last year. In our example from Craig’s, you’ll notice that Craig’s clients owe him almost $3,000 more than they did last month! If Craig knows that some of those big invoices are going to be paid in the next week or so, then that means he will have a some great bank balances soon!
Under the Assets, you will find the Liabilities portion of the Balance Sheet. This section includes all of the debts that your company owes, from credit card balances to taxes payable to installment loans. Hopefully, this is a short list!
Again, these numbers are particularly helpful when you look at them in comparison to last month or last year. In the Craig’s Landscaping example, there is a sudden addition of a $25,000 Note Payable in the June 30th balances. Obviously, Craig took out a bank loan in June, but where did the cash go? Especially when dealing with bankers, you need to be clear on where the cash is going! In reviewing the Balance Sheet, it looks like some of the loan was used to increase the cash in the bank accounts and a new truck was purchased.
An important concept to discuss at this point is Liquidity, or your ability to settle current debts with current assets. The Current Ratio is an important measure for understanding your liquidity. Divide your total Current Assets ($13,341.29 in our example) by your total Current Liabilities ($6,097.33 for Craig’s). Ideally, your Current Ratio should be 1:1 or higher. For Craig’s the Current Ratio is 2.2:1. In the landscaping industry, the average Current Ratio is closer to 1.2:1, so Craig’s is actually doing very well in comparison.
Liquidity is important for your business! It is important that your business can pay its debts that are coming due in the next year or your growth will be stunted while you’re trying to negotiate a bank loan or new investors to bail you out. Don’t be that business owner! Instead, start planning now for how you will pay your debts now and over the next twelve months.
Don’t let the Equity portion of the Balance Sheet intimidate you. It just does the math for you: Total Assets minus Total Liabilities equals Total Equity. This Equity represents how much you have invested in your business.
Last, but certainly not least, you want to make these reports a part of your monthly routine. Each month, close out your books, reconcile your accounts and run your Balance Sheet Report. Use this report as a report card for your business to see how well you’re doing in keeping your debts under control and enough cash in the bank to keep your business running.
Now you know how to read a Balance Sheet! Pat yourself on the back with the knowledge that you’re now ready to steer your small business towards better profitability and the next level of business growth. Congratulations!
Have a question on how to read your Balance Sheet? Leave a question below.
Don’t forget to come back next week for a deep dive into comparing your actual numbers against your budget. Trust me, it’s not as boring as it seems!
Deb Howard Greenleaf, EA, CEO and Principal, of Greenleaf Accounting Services provides virtual accounting and bookkeeping services and specializes in financial management to consultants, coaches, solo professionals, and other small business owners across the US. Deb is an Enrolled Agent (EA)—an IRS-licensed tax professional—and specializes in small businesses and entrepreneurs filing Schedule C or as an LLC. As an Advanced Certified QuickBooks ProAdvisor, Deb spends her day in QuickBooks Online and specializes in providing QBO support.