How to read and understand your balance sheet
CAN you advise me on how to read and understand my Company Balance Sheet? The balance sheet is a vital financial document for your business so learning what it means and how you can read it can make a big difference. What is a balance sheet? A balance sheet tells you something about the financial strength of a business on a particular day – usually your year or month end.
It will show you all the financial assets and liabilities of the business. Assets means what a business owns or has a right to, and that can be valued in money terms. Liabilities show what a business owes.
There are different ways to value those assets and liabilities. For instance, you could value a building at the amount it cost you to buy, or the amount you could expect to get if you sold it today.
Usual practice is that the values will be based on the amount paid out or received by the business on the date of the transaction. Adjustments to values will normally be explained in the notes to the accounts. Does a balance sheet show you what your business is worth? No, a balance sheet is not designed to show you the market value of your business.
The market value of many assets can be different to their historical cost on the balance sheet. For instance, a property could be worth a lot more than the business paid for it.
Also, your business may have assets that aren’t included on the balance sheet, such as goodwill. These hidden assets are difficult to value, but in the event of a sale could enhance the sales amount.
It’s important to recognise that a balance sheet is a snapshot of the business on a particular date. The snapshot could look quite different on another day. In what way does a balance sheet balance? The balance sheet is based on the fundamental truth that the assets and liabilities of a business will always be equal. To get your head around this you may need to firstly realise that for accounting purposes a business is viewed as separate to its owners.
Imagine a business that is just starting up and its owner placing €100 in the business bank account. The business now owns an asset of €100. But at the same time it also has a liability of €100, because it owes that amount back to it’s owners. The Balance sheet would look like this Assets: Cash in bank €100 Total assets €100 Liabilities: Owner’s investment €100 Total Liabilities €100
Balance sheets differ between industries. For example, the balance sheet for a shop will probably show very little in the way of trade debtors because most sales are made in cash form. But a solicitor generally sends invoices to clients and then has to wait a period of time before they receive the money. Their balance sheet would include trade debtors.
Here is a general 5-point method that you can use to weigh up a balance sheet. 1.Are net assets positive or negative? 2.Are net current assets positive or negative? 3.Consider how long it takes trade debtors to pay? 4.Consider how long it takes to pay trade creditors? 5.Consider the debt level. Jim Doyle ACMA QFA is a partner in RDA Accountants, offering full accountancy, business advisory, tax advisory and financial services | 5 Upper George Street, Wexford | Louisville House, Waterford Road, Kilkenny | | www.rda.ie RDA Wealth Ltd trading as RDA Accountants is regulated by the Central Bank of Ireland
RDA Accountants 053 9170507