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Business owners that understand their numbers are more profitable than those that don’t. Some business owners make decisions based on “gut feel” or the amount of money in the bank account. These decisions can prove to be toxic and detrimental to the business. It is important that businesses have accurate and timely financial data. Accurate and timely financial data starts with accurate bookkeeping.
Last week our blog explored the structure of a profit and loss. This week we explore the structure of a balance sheet.
The balance sheet is a report that shows the financial position of a business. It shows you how much a business/company has (assets), how much money it owes (liabilities) and how much will be left for the business owners – (assets minus liabilities equals owner’s equity). The table below outlines the structure of a balance sheet.
|Current Assets||Assets that are expected to convert to cash within 12 months. (Liquid assets)||e.g cash at bank, accounts receivable, stock on hand, prepaid expenses|
|Non-current assets||Long term assets that are not expected to convert to cash within 12 months||e.g. shares in other companies, plant and equipment, intangible assets (goodwill, trademarks)|
|Current Liabilities||Amounts owed that are expected to be paid within 12 months||e.g bank overdraft, credit cards, accounts payable, GST payable, income tax payable, interest payable, accrued expenses|
|Non-current liabilities||Amounts owed that will be paid after the current 12 month period||e.g long term debt – bank loans, long term leases|
|Owners’ Equity||The amount that belongs to the owners (assets – liabilities = owners’ equity)||e.g accumulated earnings – the earnings of the business from prior years, retained earnings – the earnings of the business from the current financial year, paid up capital – amount paid for shares|
Key Balance Sheet Ratios
The data in your balance sheet can be used to calculate ratios to show the financial health of your business.
|Ratio||How to calculate||What it measures|
|Quick Ratio||(current assets – stock on hand)/current liabilities||The ability to pay short term obligations with the most liquid assets|
|Current Ratio||current asset/current liabilities||The ability to pay short term liabilities|
|Debt to Equity||total liabilities/total equity||Shows how the business has been financing growth, through debt or through equity|
|Debtor days||(aged receivables/revenue)*365||Measures how quickly cash is being collected from accounts receivable.|
|Stock turnover||(stock on hand/cost of goods sold)*365||Measures the average number of days a business holds stock before selling it.|
|Creditor days||(aged payables/cost of goods sold)*365||Measures how long it takes a business to pay accounts payable.|
|Cash conversion cycle||debtors days + stock turnover – creditor days||How long it takes to convert stock and inventory into cash.|
Remember, what you measure you manage. There are many balance sheet ratios and it is important to understand those ratios that reflect the drivers of your business. Accurate and timely financial statements will enable you to calculate monthly ratios and monitor the financial health of your business.
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