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Impress your bank manager! How to read your balance sheet

Written by: Mark Gwilliam

Article Overview: If you want to do well as a small business owner, it would help you if you could understand the basics of how to read a balance sheet. The balance sheet is an indispensable part of a business accounting information and is essentially a snapshot of a company at a specific point in time. The balance sheet lets you know what a company owns (“assets”) and what it owes (“liabilities”). It will also tell you how much the business is worth.

Impress your bank manager! How to read your balance sheet

The company’s assets can normally be divided into current assets and non-current assets. Current assets have a high liquidity value and can be turned into cash quickly. Some examples of current assets which are stated in a balance sheet are cash, accounts receivable (also called debtors), and inventory. Non-current assets, on the other hand, cannot be easily converted into cash. Some examples of non-current assets are machinery, buildings, or real estate.

The company’s liabilities can also be divided into current and long-term liabilities. Current liabilities are debts that the company must pay back in less than a year. Some examples are accounts payable and 12 months of interest payments on longer-term loans. Long-term liabilities are debts that are due after a minimum of one year.

Shareholder’s equity is made up of the money that was invested into the business at its start and retained earnings. Retained earnings are profits that are not paid out to the company’s owners but are re-invested into the company. Shareholder’s equity is the company’s net worth.

So now that you understand the basic components of the balance sheet, let’s take a look at what types of analysis can be generated from it.

The information in a balance sheet is used to generate many different types of financial ratios. Though we will not get into the mechanics of these ratios in this article, it is important that you understand that they are used to gain insight into many diverse aspects of the business.

Debt-to-equity ratios, for example, will show how extensively the company relies on debt to finance its growth. Financial strength ratios will tell you how good the company is at repaying its debts.

In conclusion, the balance sheet’s purpose is to let you know the business’ financial health and liquidity at a selected point in time. Investors and lenders prefer that the current assets of a company are higher than the current liabilities because it means the company will remain solvent in the immediate term. Cash shortages are then unlikely and the company will not have to rely on additional funding to meet its obligations.

If you dig a little deeper into the types of analysis that can be done with balance sheet items, you just might be fascinated. With a little basic knowledge, you’ll impress you bank manager and even your accountant!

If you are interested in learning more about how to measure the health of a company, read my article called the “Top 5 Warning Signs that your Business is Declining”.

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Article Tags: accounts receivable, balance sheet, business debt, cash accounts, current liabilities, debt to equity ratios, debtors, examples of current assets, financial health, financial ratios, financial strength, interest payments, liquidity, long term liabilities, many different types, net worth, non current assets, strength ratios, term loans, time investors



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Prequalify an existing business - Getting pre-qualified for financing is a very important step in due diligence when purchasing or starting up a business. But how many people know that also prequalifying an already existing business (an aquisition) that you plan to purchase is equally as important? I cannot even begin to tell you how many people either not seeking a bank loan or can't get one because the bank thinks the risk is too high so they end up financing the business via personal means and commit financial suicide each year because they purchased a business that is doing poorly. When going to a bank, they want to review a good business plan and the business tax returns to ensure they are not taking on a losing business deal. I've heard of people who lost life savings, retirement funds, took out a 2nd mortgage or Home Equity line of credit or borrowed money from frends and family to buy a business that was losing money. They either do not know any better or they thought they can turn the losing business around. The risk of assuming you can turn a business around is too high and there isn't a lender out there who will finance that for you, so why would you? Here's some tips- Stay clear of business owners not willing to release official business financials such as tax returns. Be wary of those who say their business is actually doing well, but then say their tax returns do not reflect that information because they are not claiming all their income. A lot of business owners will show a balance sheet or monthly or yearlyProfit & Loss statements to the prospective buyer (that anyone can create on a computer) which means the documentation can be false. Speak to a professional and have a professional look over the business tax returns, whether or not you plan on doing a bank loan. Make sure that what you are getting into is a good deal from the get go.
Interrealtionship between financial statements - The transactions of the business affects various financial statements like the cash flow, income statement and balance sheet. Is it necessary to post the entry in all the three financial statements.
Sound Cash-flow & Balance Sheet - Cash is most important, if you are loaded up with good money, you just need to allocate it to right place, get the right price and make the profits. Your employees will be happy to work with you when you show good enough balance sheet of your accounts, it matters in big way, also customers want to see your company doing well.
help - what is a spec sheet? a investor wants me to provide a spec sheet but i have no idea what it is. I have a business plan in place. are they the same?
Re: Interrealtionship between financial statements - Yes, it’s necessary to take a complete toll of account transactions. If you don’t, then how would you be able to track your financial figures? For example, If a person sold goods for USD 5,000.00, half in cash and half in credit, then with taken impact of all three i.e. cash flow by USD 2,500.00 balance sheet through both cash and receivable and income/P&L statement by USD 5,0000.00, the transaction will not be complete.


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