Understanding Your Balance Sheet

Understanding Your Balance Sheet

The balance sheet is a complete snapshot of your business’s wealth. In simple terms, it works on the accounting principles of assets less liabilities = owners equity. But what we will do is explore the balance sheet’s components to understand it better.

Firstly, a reminder of the components of the balance sheet:

Assets

  • Bank accounts
  • Debtors (i.e. monies owed by customers)
  • Office equipment
  • Buildings etc

Liabilities

  • Credit cards
  • Bank loans
  • Creditors (i.e. suppliers owed)
  • GST obligations
  • PAYG obligations
  • Super obligations

Equity

  • Capital introduced (i.e. monies put in by yourself)
  • Drawings (funds withdrawn from business for personal use)
  • Profit (loss) to date

So, assets are resources controlled by the business and expected to provide future benefits for your business.

A bank account is an asset as long as it is not in overdraft. If it is, it should really be in the liabilities section. However if it is an adhoc occurrence, it will probably be shown in the assets section as a negative.

If you invoice clients/customers on credit, then you’d have a figure in the debtors section if these invoices remain unpaid. As soon as they are paid they are removed from this figure. So, basically this figure will show you at any time the total figure outstanding for customer invoices.

Assets such as office equipment, cars, buildings, leasehold improvements are basically items that have a life greater than one year. The business can benefit from them for many years, this is why they are capitalised (i.e. made an asset) rather than expensed (in the profit and loss). However they are expensed each year with depreciation or amortisation. This represents that the value of the asset is declining as the asset gets older. Assets get depreciated at different rates depending on the method of depreciation chosen and also the type of asset and thus perceived life existence.

Liabilities are commitments you have made that involve you owing money and/or other assets to another entity, be that a credit card company, lease companies, bank, ATO, trade creditors, family, friends, employee deductions and superannuation.

The obvious liability items are credit card debt, bank loans etc. The not so obvious ones are due to obligations that you incur if you have employees and/or are registered for GST. Firstly, when paying employees, rather than paying the gross wage you pay the net wage and thus you are subtracting the tax out of their wage to submit later to the ATO on their behalf. This may be monthly or quarterly. Tax deductions from an employee’s wage gather in a liability account on your balance sheet until such time as you pay this debt to the ATO, usually through your BAS payment.

The same applies to GST. When we spoke about the profit and loss report I mentioned that this will always show revenue and expenses exclusive of GST if you are in fact registered for GST. Therefore whenever an entry is created in your accounting software for a sale or expense, the applicable GST will be spirited off to a GST payable or GST collected account in the liability section of the balance sheet. Again this collects here until such time that you pay your BAS.

Superannuation also calculates with each payroll processed. Thus the expense occurs in the profit and loss and the obligation arising from this appears as a liability in the balance sheet, until such time as it is paid.

The balance of your business (after subtracting your liabilities from your assets) will be the equity that you have in that business. In other words, the interest the business owner has in the business after all debts have been settled. Usually this is a positive figure meaning that the assets you own are a greater value than the liabilities you owe. Sometimes it can be a negative figure which shows that the liabilities you owe are greater than the assets you own. Not a fantastic position to be in because you would be too highly geared by debt.

So what are the components of equity in the balance sheet?

  • Capital introduced (i.e. monies put in by yourself)
  • Drawings (funds withdrawn from business for personal use)
  • Profit (loss) to date

If you have introduced your own funds to your business (i.e. not borrowed) this will show in here. Likewise any withdrawals of funds you take of a personal nature can show up as drawings (this can depend on your tax structure – see your tax accountant). If you withdraw more funds than the business can handle, you can literally kill it. This can be a component of when you are making profits but there is no money in the bank because you have withdrawn it and then some. If that’s you – just stop! Live within your means, but don’t bankrupt your business.

You will also see the year to date result from your profit and loss, as this is what the business is contributing to the wealth of the business. Therefore if you take your profit and loss result at a certain date and look at this figure in your balance sheet as at the same date, these two figures will match.

In summary, assets provide your business with future benefits (to derive income), which are first utilised to meet the obligations (liabilities) of the business BEFORE business owners can receive their remaining entitlements. As a business owner, you are obligated to pay your liabilities but not obligated to entitle yourself as the business owner. Good practice, for sure. Obviously we all need to pay ourselves, but we just need to make sure we don’t take it too far!

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