The Basics of Small Business Balance Sheet

In this article we will discuss how to read a small business Balance Sheet including a discussion of assets, what you own; liabilities, what you owe; and equity which is the difference between the two.

Assets include the physical assets you own such as equipment, inventory, vehicles and buildings. These assets listed on your balance sheet may or may not reflect their true value. For example, if you purchase a factory building you will carry it on your balance sheet at cost and depreciate it over time. However, the value of the real estate may increase and worth more than the paper value. You will also carry inventory on the books at cost even if you assemble product - the item you sell - from raw materials. The product for sale will be carried on the books at cost which includes cost of raw materials and labor to assemble the product but not any markup or margin that will be gained when the product is sold. The SAP - standard accounting practice will vary slightly by industry. For example when we build a house for sale it is carried on the books at cost. If the home is pre-sold and being built to order we can carry it on the books including mark up. The difference is that for profit purposes you realize the profit on a prorate basis each month as the home is built. If you do not sell the home until it is complete you realize the profit when it is sold. Interest on the home is also capitalized which means it is carried on the books as an asset just like lumber or any other cost and becomes an expense only when the home is sold.

In a retail business you carry the items you buy at your purchase price - wholesale - as inventory. You may expense the shipping cost of bringing those items into the store at the time of delivery. Accounts receivable, what your customers owe you including pending credit card payments, is also an asset.

Assets may also include items that are far less intuitive. Pre paid taxes or insurance are not an expense but and asset. The expense is realized when the tax or insurance is due.

You may also have assets that have a subjective value such as customer lists, brand name, and good will. Good Will is the value of being an established business instead of a new start up. Often these are not shown on the books at all or carried at one dollar but these items can be of significant value when the business is valued for sale.

Liabilities are what you owe to banks or other lenders, accounts payable - what you owe vendors, - accrued payroll expenses such as taxes and benefits. Liabilities also include customer deposits on products or service you have not delivered.

Equity is invested capital and retained earnings. This is often referred to as book value. As discussed above it more often than not does not reflect the true value of the company.

Now you understand the basics of how to read a small business balance sheet. In future articles we will discuss ratios and what they mean to your business.

All original content ©Thomas Robinson 2010