Understanding Your Balance Sheet
Most owner managers profess to understand very little about the balance sheet that appears in their accounts at the end of the year. This article is designed to remove some of the mystery surrounding the balance sheet and help you understand it a little bit more.
Balance Sheets generally show the underlying value of your business and what it could be worth to a potential buyer.
Why is the Balance Sheet so important?
Well first of all it reflects the solvency of your business; if it's going up your company is getting financially stronger. For most owner-managed companies, it is the only piece of information that the outside world knows about as the Balance Sheet is filed at Companies House annually meaning that credit checking agencies draw all their conclusions from this one document.
What appears on the balance sheet?
All the assets of the business appear on the balance sheet, although they are not always included at their true valuation. Whilst the short term assets like the Bank balance will be accurate at the year end, it will undoubtedly be a different figure today. Longer-term assets (known as Fixed Assets) are shown at the book value. For properties this might be original cost, thereby potentially undervaluing the business. In addition goodwill rarely appears on the balance sheet of the business unless it has been purchased from a third party or possibly been re-valued. There could be a huge amount of value in goodwill - this could be the value of your client list, your brand or your bespoke products or services.
The liability section shows the amounts you owe to third parties. These might be current liabilities (amounts due within the next 12 months) or long-term liabilities such as bank loans.
What not included?
What doesn't appear on the balance sheet is a liability for the costs of closing the business down such as redundancy, meaning that the common assumption that the net assets figure on a balance sheet is the figure that the owners will be left with if they were to shut the business down is incorrect.
Ultimately there were only three ways that the business can increase the net assets on its balance sheet. The first way is to make a profit; that profit will turn itself into assets or will contribute to reducing liabilities. The second way is for further capital to be introduced by the owners and the third way is to revalue items on the balance sheet although there should always be a good reason for doing so.
If you would like to take your business forward find out about A4G's Virtual FD service, email firstname.lastname@example.org or call 01474 853856.