subject: Grasping Assets: How To Read A Business Balance Sheet [print this page] Your business balance sheet is one of three primary financial statements. The other scorecards of business health are the income statement and cash flow statement. You can determine your company's financial health and identify business trends through the accurate interpretation of your financial statements. Improve your strategic planning by understanding how past decisions have shaped your financial condition today. The key is to learn and grasp the critical elements of the balance sheet to become an informed financial statement reader. So let us take a look at the first business scorecard, the balance sheet.
The balance sheet is an important business scorecard. Your net worth (i.e. your equity or ownership in the business) is determined by your assets (what you own) and your liabilities (what you owe). The balance sheet is a snapshot of your business at a specific point in time. A company usually prepares a balance sheet at the end of a month, quarter or year but you can use any point in time. You can compare the balance sheet to a prior period to determine the improvement or decline in your business condition. The values on the balance sheet can be market or book values depending on the accounting rules applied.
The results of business operations that impact your balance sheet are normally reported at the end of a month, quarter or year. Here is what you should see when you look at your balance sheet.
You should own more current assets than your bills currently due. One of the most critical indicators of a company's financial strength is its liquidity or the ability to access cash to pay bills that are coming due. Your current assets are cash, short term investments and other assets that can be quickly converted into cash. These assets should be worth more than your current liabilities which generally are amounts you owe within the next twelve months. The current ratio, or the amount of current assets divided by current liabilities should be at least 1:1. A ratio below this level indicates you might have trouble paying bills in the near term.
The quality of assets should be increasing not becoming more suspect. You want to see cash coming in the door after sales have been made. Cash is a very high quality asset that can be deployed at face value in a number of value-added ways. On the other hand a big increase in inventory might indicate there is a problem with sales, economic conditions or inventory management systems. A substantial increase in accounts receivable might mean your collection procedures need an overhaul or your credit standards are too loose. Management should take notice of heavy increases in these types of lower quality assets.
Your total debt should be a reasonable percentage of your total assets. Business owners and managers face a big challenge with too much leverage. Over-borrowing is an easy condition to develop but very hard to cure. Your total liabilities including current, short term and long term money owed should be in line with other companies in your industry. A capital intensive industry typically requires heavier debt loads to purchase plant and equipment. A service industry requires a much lower leverage level. Your company will have a competitive disadvantage with too much debt service and reduced operating agility if you are substantially outside the industry range for the total leverage ratio.
Your net worth should be positively positive. Your company should own more than it owes. Look for earnings that have been retained in the business over time which may indicate a commitment to future growth from management. Check the composition of ownership. Is your company heavily owned by insiders or outside investors? Company ownership should include insiders that have their lifeblood tied to the success of the company. A business owner or leader that has little invested in the company has less incentive to put the company's interest ahead of their own. Insider confidence in the company may be indicated by a high level of treasury stock accumulated through stock repurchase programs.
Pay close attention to your balance sheet. Business management decisions and the outcome of earlier strategic plans are reflected on this important scorecard. What you see on the balance sheet is what you have to work with as you make new strategic plans for business growth during your financial planning process.
