Understanding Balance Sheets

Balance Sheets are Beautiful

It’s that time again, your accountant has just handed you the business’ financial reports, now where do you look?  Most people turn to the Profit and Loss report and look straight to the year’s result, hoping to see black ink to show the business has posted a profit. Next, most business owners will look for how much tax they will need to pay (or maybe get back).

While it’s nice to see a profit, and I understand the impact tax has on short-term cash flow, neither of these items are the most important piece of information in the document. The thing that sets most successful business owners apart from their peers is their ability to read and understand the Balance Sheet (aka Statement of Financial Position).

Why? A well developed and produced Balance Sheet can tell you more about a business’ future than the Profit and Loss.  To understand why, let’s look at what constitutes a good Balance Sheet.

It starts with a simple formula: Assets = Liabilities + Shareholders’ Equity

This universal truth of accounting states that the value ofa business’ assets will equal its obligations.  Why is this?  Short answer: accounting is beautiful! Long-answer: basically the difference between what a business has, and what they owe, is what is left for thebusiness owners.

The accountant in me could talk on the beauty of this equation for weeks on end… but let’s move on! What are the key items on a Balance Sheet?

  1. Current vs. Non-Current: What does it mean to be Current? This implies you expect this asset (or liability) to be redeemed for cash within 12 months. Non-Current means it is going to last longer than that. Why is this important? The ability to turn an asset (or liability) into cash is key to understanding the liquidity of a business and if a business is deemed to have liquidity, it is more likely to survive.
  2. Goodwill: Many businesses don’t take the time to analyse some of the more intangible line items on their Balance Sheet. Recognising  the goodwill embodied in a business is important if you ever want to sell your business. (And if you don’t want to sell your business, you’d better be getting paid well in the interim, otherwise why are you doing it!)
  3. Depreciation: Recognising if you claimed some of your tax deductions early is also important. How? Identify if you’ve claimed some extra depreciation in advance of how long the asset will actually last. Why? With accelerated SBE Business depreciation it is really easy to get a surprise tax bill in the following years AND if you are looking to sell any of the assets, you can get a surprise tax bill if you sell the asset for more than the carrying value.

If your Balance Sheet lines are classified correctly, you can quickly analyse the long-term financial opportunities afforded to the business.

I think it’s safe to say that if you are still reading at this point, you are either genuinely interested in knowing more about your business and should ask your accountant to explain your Balance Sheet, or you’re a fellow accountant who needs to get a life and meet some new people.

Either way, we’d love to talk to you about the beauty in your Balance Sheet. Give the team at PB&F a call if you’re interested in improving your business’ value.

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