Given my healthcare background, I often see similarities between medical practices and business practices. As an example, when you go in for a visit to your doctor’s, someone is likely to take your blood pressure, pulse and respiration. These are termed “Vital Signs” as they provide a quick initial assessment of your physical health. Should any of these initial indicators be outside expected norms, further, more detailed tests are performed
Similarly, you as a business owner can get quick assessment of the financial health of your business through three financial statements – the Balance Sheet, the Income Statement and the Cash Flow Statement. These constitute the “Vital Signs” for your business. Should any of the indicators that are developed from the data in these statements by outside expected ranges for the industry, more detailed analysis would be performed.
This first article will take a look at the Balance Sheet. Succeeding articles will explore the Income Statement and the Cash Flow Statement.
It is my belief that the Balance Sheet is the most important of the financial statements. The balance sheet reflects how much a business OWNS and how much the business OWES as of a particular date. It is a snapshot in time. The Balance Sheet at the end of one period (ending balance sheet) becomes the beginning balance sheet at the start of the new period. The Balance Sheet derives its name from the requirement that what the business owns must equal what the business owes. Visualize a pharmacists balance scale and you’ve got the picture.
One side of the balance sheet presents what the business OWNS. These are called Assets. The other side of the balance sheet reports what the business OWES to people outside the business (Creditors) and people inside the business (Owners). The people outside the business are referred to as Liabilities and the people inside the business are identified as Equity Owners. The accounting formula specifies that Assets must equal Liabilities plus Equity.
Both Assets and Liabilities are further divided in Current and Long Term sections. The current portion reflects a belief that these items will be used within a years time. Current assets consists mainly of Cash, Accounts Receivable and Inventory. Current Liabilities includes Accounts Payable, lines of credit, other payables (wages for instance) and the current portion of long term debt.
The long-term portion of Assets consist of Fixed Assets (equipment, vehicles, buildings, etc) and Intangible Assets (patents, trademarks, intellectual property, etc). The long-term portion of Liabilities presents the long-term debt picture. It is expected that long-term Assets and Liabilities will extend into the future beyond a years time.
Equity reports the portion of the business owed to those inside the business. Equity includes owner investment, retained earnings from prior fiscal years and net income from the current year which matches the net profit reported on the income statement.