Whether you’re running a successful business or interested in buying one, it’s important to understand the various financial documents that a company produces. These reports help you know what’s going well, what’s going poorly, and whether the company has a healthy long-term outlook.
The balance sheet is a report that helps you look at the big picture of the company. You can see the assets, liabilities, and owner’s equity. These are generally prepared once a quarter or once a year and represent the business’s current financial position.
Here’s what you need to know about each balance sheet category:
Looking at Assets
The first part of the report will tell you what resources the business has. This can help you value the company and know exactly what you’re buying. Or, if you’re an owner, it can give you a good idea of how strong your company is.
You don’t want to look at just the amount of assets but also how high-quality they are. That means, how likely are you to be able to turn that asset into the appropriate amount of cash? Of course, cash on hand is the highest value, and aging account receivables have far less value.
Pay attention to the age and quality of the inventory and how close major assets are to the end of their useful lives. The net value of an item is its initial value minus depreciation, so that’s an important number to note.
Next, you’ll look at liabilities. These are debts that the business owes to others. You might see accounts payable to specific vendors, loans from the bank, or other liabilities. When you’re buying a business, you may choose to buy only the assets, but the seller may also require you to cover the short-term liabilities like accounts payable.
Any liability that’s due in 12 months or less is a short-term liability. Long-term liabilities include long-term loans, bonds the company issued, or other long-term debt.
Owner’s Equity (Book Value)
The amount left over after you subtract the liabilities from the assets is the owner’s equity, or book value, of the company. This is what belongs to the business owners. Some of the items in this category include invested capital, retained earnings, and the amount of equity drawn out of the company to pay owners.
Theoretically, the book value is what you would get if you liquidate the company rather than sell it. It’s a good bottom-line number so that you know how much you could get back if everything goes poorly.
As a business owner, it’s essential to trim your expenses and keep your book value high. Of course, there might be periods of higher costs, but those should be temporary. Use the balance sheet to understand where you can cut costs and improve your business situation.
Your Balance Sheet Reflects Financial Health
Now that you understand the three parts of the balance sheet, you can see how it reflects the business’s financial health. A company with low cash, older assets, and high liabilities is in a dangerous position.
On the other hand, having substantial cash reserves, newer assets, and low liabilities makes your company more attractive to buyers.
If you’re interested in buying or selling a company, don’t go it alone. There are too many ways you can leave money on the table. Instead, let us help you get the deal that works best for you. Contact us today for more information!