What Your Financial Statements Really Mean

The balance sheet is the primary way to determine how well your company is doing financially. You can also use the balance sheet as a road map to determine where your company is headed in the future. You will need to refer to your company's balance sheet when you prepare your tax return or apply for a loan. It is important to understand what should be included on a balance sheet to ensure that your bottom line figures are correct. You don't want to be in the position of making a decision for your company based on faulty information. ‍

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Determining Your Business Assets

Assets represent cash and items of value that are immediately available for your business to use. It can also include money or goods that you are owed on behalf of your business and expect receive within the next year.

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There are several different categories of assets, including the following:

• Accounts receivable is the term used to describe money that is owed to you from customers. This usually happens when you sell and ship merchandise to a customer and don't require payment immediately upon receipt. An accountant tracks a company's accounts receivables from the time the goods are delivered until final payment is received. The average accounts receivable invoice is paid within 60 days.
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• Cash is the amount of money your company has on hand to pay normal business expenses like employee salaries and utilities. It includes all money you have in checking, savings and money market accounts on behalf of your business. It does not include inventory, machinery, accounts receivable, buildings, land and equipment that can be sold for cash. The biggest reason that businesses fail is lack of consistent access to cash flow.
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• Inventory is the term used to describe materials and goods that a business buys and then resells for a profit at a later date. Accounts receivable are generated once goods have been produced and sold. When inventory is sold, it does not result in immediate profit for the business. It is important to manage this well to avoid having too much of your company's profits in the form of inventory rather than cash.
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• Notes receivable is when the business makes a loan to a customer, officer of the business or an employee with a promissory note for repayment within the next 12 months. Most small businesses with limited financial resources will never incur a notes receivable.
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• Other current assets is the catch-all phrase for prepaid expenses and assets that don't fit into any other category.

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The total assets represent all cash and assets that you own on behalf of your business. This includes assets that are owed to your company that you have yet to receive.

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‍Fixed Assets and Intangibles

A fixed asset is something that you purchase with cash from the business that is expected to last for more than one year. Examples include fixtures and furniture, buildings, land and leasehold equipment. Intangibles include items with a value that is difficult to determine. As a result, these items may never mature into a cash asset. Most business owners deduct intangible assets from their net worth rather than count them as genuine assets. Some examples of intangible assets include organizational expenses, research and development, patents and market research. An intangible asset is similar to a prepaid expense in that its benefit is not immediately known.

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‍Determining Your Business Liabilities

The current liabilities of your business are those that will mature and become payable in the next 12 months.

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These include the following classifications:

• Accounts payable is the money that your business owes to suppliers and creditors that have provided your company with a cash loan, inventory, goods or services. You can save money by taking advantage of early-pay or volume discounts offered by your suppliers.
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• Accrued expenses are those that your company owes in the absence of a formal bill. Examples of accrued expenses include payroll, employee benefits and payroll taxes.
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• Current portion of long-term debt (LTD) is money that your company must pay within the next 12 months on items like the business mortgage and major pieces of equipment.
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• Notes payable is the amount you are required to pay on an outstanding obligation within the next 12 months. It includes only the principal amount of the loan as the interest is included in accrued expenses.

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Non-Current Liabilities‍

A non-current liability is one that you are obligated to pay in the upcoming year. These include your non-current portion of LTD, contingent liabilities and notes that must be paid to shareholders, officers and other owners. The Small Business Administration (SBA) describes a contingent liability as one that may or may not ever come due. Examples of contingent liabilities include potential lawsuits, guarantees and warranties. They are listed in the footnotes of your balance sheet due to their unknown nature. The total liabilities of your business are the sum of all creditor claims and money that it owes to suppliers, employees and others.

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‍Determining Your Company's Net Worth‍

To calculate your current equity in your business, deduct your total liabilities from your total assets. This represents your share in the financing of all assets and is also referred to as your net worth.

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‍Preparing Your Company's Income Statement‍

When you apply for any type of bank financing, lenders almost always request a copy of your company's income statement. This document is also known as a profit and loss statement. It shows the amount of money your business is expected to earn after all expenses have been accounted for and deducted. A person reading an income statement starts at the top and reads all the way to the bottom to understand expenses and earnings over a specified period of time. However, an income statement should only be taken at face value. It does not reveal legitimate financial problems your business may be experiencing, such as a shortage of cash flow.