We’ve already explored why you should be reviewing your financial reports monthly, and today, we are diving into your Xero balance sheet.
For some small business owners, a balance sheet is as meaningless as that essay before an online recipe. It’s simply a senseless collection of numbers and data, and they have better things to do than try to crack that code.
Sadly, these business owners are sitting on a gold mine of valuable information without even realising it. Your balance sheet allows you to understand the financial position of your business at a particular point in time (which is why it also goes by the name ‘statement of financial position’).
If you throw in your Profit and Loss Statement and any other key financial reports, you will have a full picture of your financial position and know exactly how your business is performing. The more we understand our business’s numbers, the more informed decisions we can make.
So love it, hate it, or misunderstand it, but the balance sheet is one of the main reports every business owner should be reviewing every month – without fail. So, how do you read one?
The make up of balance sheet.
Your Xero balance sheet has three main sections – assets, liabilities and equity. We’ll jump into what each of these sections includes, but first things first, clean up those books.
An accurate balance sheet stems from accurate bookkeeping. So block out time in your calendar, and schedule in a monthly spring clean of those books of yours. Running a report on Xero is the best way to view your balance sheet, and we’re not budging on this one because you can run every report under the sun with Xero.
Pro tip – A good accounting habit to adopt is ‘locking your books,’ which means you cannot amend past entries once finalised.
What is an asset?
If your business owns it, chances are, it’s an asset.
There are many different types of assets, but they should all have a current or future value measured in a currency. Think equipment, vehicles, investments, supplier deposits or bonds, stock on hand, banks and other financial accounts held – you get the gist. All of these have a monetary value. You can then break down your assets further into Bank Accounts, Current Assets, Fixed Assets, Inventory, Non-current assets (AKA long term assets), Intangible Assets and Pre-payments.
What is a liability?
Liabilities are the amounts you owe to suppliers or any other creditor for the goods or services you have already received.
They can also include amounts you have received in advance for services your business is yet to provide. Falling under the liability umbrella is your accounts payable (trade creditors), payroll obligations (salaries, taxes, superannuation), interest, customer deposits, received warranties, and loans.
Your Liabilities are also subdivided on your balance sheet, typically into current and non-current liabilities.
What is equity?
Last but not least, we have equity which includes owner funds contributed, drawings, retained earnings and stocks.
The value of your equity is equal to your assets minus your liabilities. Any transaction that affects your profit and loss accounts will also affect your balance sheet accounts. So if you provide a service that increases your accounts receivable balance, it will also increase your equity.b
How to balance your balance sheet.
Your balance sheet must always balance. Asset value = liabilities + equity. Take note of that because it is one very important equation.
To see it in action, let’s say you purchase a new vehicle for your business at $50,000. You pay a $10,000 deposit and take out a $40,000 loan. The value of your liabilities increases by the $40k loan, leaving your balance sheet balanced on both sides of the equation.
If for some reason, you woke up one fine morning and decided to pay all your bills and debts while selling all your assets – your balance sheet equation will show you how much money you would have leftover. And this amount is the Owner’s Equity.
The value of your business.
Before you grow either disheartened or elated, it’s important to note that your balance sheet equity total does not necessarily translate into how much your business is worth at market value.
And there is a whole host of intricacies as to why this may be the case, for one, your assets are listed on your balance sheet at their transaction value – not their market value. Your assets may be worth more, or they may be worth less due to depreciation.
If your business value was a Facebook relationship status, it would be ‘it’s complicated.’ Many factors need to be taken into consideration before we can reach a conclusive decision.