What Can Your Balance Sheet Tell You?
Small business owners frequently think that the income statement, also known as the profit & loss (P&L) report, is their only financial statement. In truth, other reports in your financial statement "package," such as your balance sheet, will give you a much more complete picture of your business health.
Your income statement can tell you how much money your business is making, but your balance sheet is actually its ally in helping you understand your business. More specifically, your income statement details your income, expenses, and net profit over a period of time (e.g., monthly, quarterly, annually)—but your balance sheet sums up all activity at a particular point in time.
What's your business's balance sheet trying to tell you?
It outlines your company's:
Cash – your cash balance on the day of the report (usually at the end of the month)
Accounts receivable – the money your customers owe you, which will be cash upon collection
Accounts payable – the money you owe to vendors, which you'll likely be paying out within the next 30 to 60 days
Loans payable or other liabilities – the amount of money you owe to others on a payment plan or other longer-term agreement (i.e., you haven't received a bill for it but know you owe it); e.g., credit lines, term loans, owed commissions, or incurred (but not yet billed) estimated expenses
Fixed assets – your collective payments for substantial equipment or real estate, accompanied by the accumulated depreciation, which shows how much of these costs have been expensed over time
Equity – the amount left if you were to sell all of your assets and pay all of your liabilities (note that this item can get a lot more complicated than this super-basic definition), which can include:
Stock/Capital contributions – the amount of money you've invested in your business (depending on your business's type of legal entity), such as purchased stock or personal monetary contributions
Retained earnings – your company's total net income since its inception, less the money withdrawn by owners in partner distributions or shareholder dividends
Hear what your balance sheet is saying about your small business
If your cash + accounts receivable – accounts payable is positive, you should have some money to fund your business. If you divide that number by your average monthly overhead, you'll know how many months you could potentially survive a downturn in business (e.g., due to a pandemic).
With a strong net income, why does your business always seem to need cash?
That may be the case if you have:
Slow customer receivable collections – a lot of cash hasn't reached you yet because your customers aren't paying quickly enough
Significant equipment, development, or inventory costs – your cash is tied up in equipment, products for sale, or other assets needed to run your business
Why do you have cash, but your income statement shows little or no profit?
This may be the case because:
Capital investments, loans, or other liabilities – you have received cash that doesn’t need to paid back quickly, so your available cash hasn't been generated by profit
Customers pay advances on your products or services – cash received in advance is considered a liability, or deferred revenue, until you deliver the products or services
Cash available upfront can be great for your business, but it's important to recognize that you may not have earned it yet.
Overcome challenges to avoid detriment to your business health
If you need any help reviewing your financial statements such as your balance sheet, seek an accountant who can help you at least understand the most basic reports on your financial status. Once you do, you'll feel empowered to make smart decisions for your business.