Better Understand Your Business' Finances By Breaking Down the Balance Sheet & Key Ratios

Better Understand Your Business’ Finances By Breaking Down the Balance Sheet & Key Ratios

Do you know what your company is really worth?

Whether or not you use a professional bookkeeper and/or accountant, knowing how your business is doing at any given time is an essential part of success. While income statements and cash flow statements can give you a view of your business over a period of time, a balance statement (BS) can give you a snapshot view of your business as it exists at this moment. Add to that an understanding of financial ratios, and you’re well on your way to having a firm grasp of the financial underpinnings of your business!

What Is a Balance Sheet?

Simply put, a balance sheet is based on an equation:

Assets = Liabilities + Equity

In this context, your assets are what you own, your liabilities are what your company owes, and your equity is the net worth of your company.

Your assets can be either current, fixed, or long-term. Your current assets are the ones that you will be using in the near future. Your fixed and long-term assets are those held beyond one year and often depreciate in value (unless the asset is land, which tends to mature rather than depreciate). You can also include your long-term investments as part of your long-term assets. Your assets can also include intangible things like your brand, trademarks, and patents.

You can think of your liabilities similar to the opposite of your assets. Similarly, there are both current and long-term liabilities. Current liabilities are generally payables and short-term debt that can be paid within a year. Long-term liabilities can include debt to the bank or to your investors.

Finally, equity can be different depending on the structure of your company. If you operate as a sole proprietor or partnership, you’ll likely have an owner’s equity. If your company is a corporation, then you’ll probably have shareholder’s equity. On your balance sheet, equity is usually made up of your retained earnings over the years; the value of what is left of the assets after all liabilities are cleared. This can also be where your capital stock is listed.

Let’s Look at Ratios

But how does any of this information help you? To take advantage of the data in your balance sheet, you need to look at financial ratios. The three most common kinds are:

  • Current ratio
  • Quick ratio
  • Debt-to-equity ratio

Your current ratio should lay out the liquidity of your company and its ability to pay current liabilities with your current assets. In this case, you want a ratio of 2:1 or higher, as you want to be able to cover the current liabilities you owe completely.

Your quick ratio is a more detailed version of your current ratio, removing your inventory from consideration. Much like current ratio, you want this to be 2:1 or higher. That being said, you don’t want it to be too high, as this would mean you aren’t reinvesting your cash back into your company.

Finally, your debt-to-equity ratio is the level of debt you hold against your equity. You want no more than a 2:1 ratio here, as anything above that means your company is taking on more debt than it can handle versus your level of equity.

Having accurate metrics of how your business is doing is vital to your overall success. You can’t rely on luck alone when it comes to growth. Knowing all about balance statements and the financial ratios that can be derived from that data can be invaluable. If all of this sounds pretty complicated, don’t worry because we can help!

At The Number Works, we’ve helped countless small businesses thrive, taking care of their complicated finances. If you want to ensure that everything at your business is kept in financial balance, contact us today! We can’t wait to help you better understand all of your financial statements!

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