Balance Sheets

Video Transcript:

Welcome to the balance sheet. The balance sheet is an important tool that helps business owners report the financial position of their companies. It's a snapshot of their business at a certain point in time. In this course, you will learn what a balance sheet is and why it's important to your business, what information is included on a balance sheet, the difference between assets, liabilities, and owner equity, and how to get started creating your own balance sheet for your business. A balance sheet helps a business owner report the financial position of his or her company at a certain point in time.

You can use a balance sheet for access to loans, financial analysis, and business projections. On the left side of the balance sheet, sometimes called the debit side, you list all of your assets. Assets are things that the business owns that are used for the company's operations. For instance, you own your refrigerators, shelves, and trucks. You own any current inventory in the store and own any money that you have saved in the bank.

So where did the company get the money to buy these assets? Take a look at the right side of the sheet called the credit side. Here you will find all of the financial sources for the company's assets. Liabilities are sources of money or capital that the business owner may have borrowed from someone else. In this case, the money you borrowed from the bank and some family members are listed as liabilities.

The credit side also includes owner's equity or sources of money or capital that you, the owner, have invested into the business. For instance, when you first opened the business, you invested your own money to get things started. And over the years, you even put money you have made as profit right back into the business. As the name balance sheet suggests, the total value of the business's assets on the debit side must equal the total amount of liabilities and shareholders' equity on the credit side. The two sides must equal each other in order for the balance sheet to balance out.

In other words, total assets equal liabilities plus the owner's equity. For the past three years, you have owned your own corner grocery store. Business has been good, and you think you might expand the store. But before you start investing a lot of money and making big changes, you as the owner want to have a better understanding of the financial condition of the business. What do you own, and what do you owe?

And how much risk could you expose the business to without putting your business in jeopardy? You make a tally of the things that you own. Your refrigerator, shelves, a delivery truck, the money you have in the bank, and so on. Then you calculate how much you owe to the bank and to friends and family members. Finally, in order for you to balance your business, you determine how much of your own money you have put into the business.

This process is essentially what you do when you create a balance sheet for your own business. Let's take a look at an actual balance sheet next. Let's take a closer look at assets or things that you own. There are two types of assets, current assets and fixed assets. Whether we describe an asset as fixed or current depends on how quickly it can be converted to cash.

Cash itself, money in the bank, is the most current or liquid of all assets. When something is liquidated, you sell it for cash. Next comes inventory. In the case of this company, these are the merchandise and goods in your store that can be sold relatively quickly for cash. Sometimes your clients get goods on credit and only pay every thirty days.

The money owed to you is called accounts receivable, and this is a short term or current asset. Machinery and equipment might take longer to liquidate and turn into cash. If you needed to sell your truck or refrigerators, it might take some time to find a buyer. Assets become more fixed the longer it takes to convert them to cash. For instance, if you owned the store's building, you would have a more fixed asset.

And finally, the most fixed asset of all is land. Land can take time to sell and turn into cash. Assets are usually considered current if held for less than a year, and fixed if they're held for more than a year. Let's go back and take a closer look at the right side of the balance sheet. These are the liabilities.

Liabilities are sources of capital that belong to entities that are not the business owner. Liabilities include short term or current debts with a maturity less than one year, and long term debts with a maturity more than one year. And here's something that may be confusing. Remember the truck? That's an asset on the left side of the balance sheet.

But you took out a long term loan for 3,500 to pay for that truck. The loan appears on the right side as a liability. You might also owe your supplier, and this is called accounts payable and is short term or current liability. You also put down a thousand of your own money to buy the truck, so that appears as owner's equity. There are two types of entries for owner's equity, capital and retained earnings.

Capital is any money that you originally invested in the business, like the down payment on the truck. Retained annual earnings represent any money that you put right back into the business when you make a profit. For instance, when you had a really strong month at the store, you put the money earned into a new produce stand for the front of the store. This entry is called new money and represents retained annual earnings from your profitable business operations. Reviewing the complete and up to date balance sheet gives you an accurate picture of the overall worth and health of the business.

You can see what you own versus what you owe and know how much cash you have in reserve should you go through any slow periods. You can even see what assets can quickly be converted to cash if you need to have more money on hand. Based on the balance sheet, you decide that you're ready to take the next steps towards expanding the business even more. A typical business's balance sheet may be more complicated than the one you created, but this example should give you a good understanding of what a balance sheet includes and how you can use it.