As part of OnlineAdvisor’s efforts to educate, inform and encourage business leaders, we present key financial terms and concepts.  For this article, we focus on why a balance sheet is important as part of the important financial reports of your organization.

What It Is

A balance sheet tells us our company’s health at one specific point in time.   It’s like having a “physical exam” of a business.

A balance sheet shows us a business’s financial stability. It shows what your company owns and what it owes. It displays this information in terms of your company’s assets, liabilities, and equity.

The Components

Assets are any items your business owns. Liabilities are payments your business needs to make. Equity is the amount your business’s shareholders own in the company. On balance sheets, the assets are ideally equal to, or balance out, the liabilities and the equity.

Balance sheets keep business owners informed about your company’s financial standing. Many business owners fail to recognize their companies are in trouble because some business owners don’t read their balance sheets.

Application

For example, if you have more liabilities than assets on the balance sheet, it usually indicates that your business is in serious trouble.  That may be hard to see if you’re only looking at what you have in your business checking account – “I have money in the bank!” doesn’t fix a problem of money owed that is more than what can be paid back.

Balance sheets are also important because these documents let banks know if your business qualifies for additional loans or credit. Balance sheets help current and potential investors better understand where their funding will go and what they can expect to receive in the future. Investors appreciate businesses with high cash assets, as this usually indicates that a company will grow and prosper.

Management

Managing what we own and what we owe requires skill and understanding.  Even if you are planning to have no debt, the reality of doing business is that you will have instances where you will owe vendors, government agencies, or other people.  Additionally, you may not have debt that you have to pay right away.  Nevertheless, you will have debt that you will have to pay at some point in time.  That’s why you want to know if your company is healthy enough to manage it.