Financial literacy enables entrepreneurs to take responsibility for every dollar, maintain critical attention to costs and develop a comprehensive understanding of cash flow, profit and loss – all of which are crucial to the growth of your business.
As a business owner, you do not necessarily have to run all of the financial sides of things, but gaining some degree of understanding of your business’ finances means that you will be able to manage some of those finances, and puts you in a better position to make informed decisions.
Becoming financially aware will provide you with an understanding of your key financial reports, knowledge of important accounting concepts such as the difference between cash flow and profit as well as how to review them, and monitoring income and expenses throughout the year.
According to Astute Mode, once you have gained the knowledge and understanding of your financials, you will be:
- Better able to understand your business with a more complete financial picture
- Less prone to make mistakes so that your financial reports will be accurate
- Better able to manage and monitor your cashflow
- Able to customize your reports to ensure you capture the right information
- Be more aware of and prepared for your tax position
- Able to build a solid foundational understanding to forecast growth
- Better able to understand the financial implications of decisions you make
When you truly understand the financial side of your business, you gain knowledge that makes it easier to make better, more informed decisions and to run a more profitable business.
We mentioned that being financially aware will provide you with knowledge of the financial reports and statements and the accounting concepts that are found on these reports. The first statement we will review in this article is a balance sheet.
What is a Balance Sheet?
A balance sheet is a financial statement that summarizes all of what the business owns (your business assets) and what the business owes (the business liabilities) and how much is invested in the business (your business equity) at a given point in time.
What are assets?
We mentioned that the assets are what the business owns but they are things owned that can provide future economic benefit.
They are broken down into two categories: tangible and intangible assets.
Tangible assets are in physical form. These include:
- Cash
- Inventory
- Equipment and Machinery
- Vehicles
- Building
- Land
Intangible assets are those that do not exist in a physical form. These are like your intellectual property and copyrights that you own. Other examples are:
- Patents
- Goodwill
- Trademarks
- Brand
- Licenses and permits
On a balance sheet, you can compare your assets to your liabilities to assess the value of your business. The more value you have, the more attractive you may be to investors. Additionally, the more your assets outweigh your liabilities, the stronger the financial health of your business.
What are liabilities?
Liabilities are any money or other items that your business owes to outside parties. Essentially, liabilities are your recurring expenses, loan repayments and other forms of debt. Liabilities can be broken down into current or long-term liabilities.
Current liabilities are the financial obligations that are due within one year or a normal operating cycle. Some examples of current liabilities are:
- Rent
- Utilities
- Taxes
Long-term liabilities are those that are not due within a year. They are also not due within the company’s operating cycle.
These include:
- Bank loans
- Mortgages
- Notes and bonds payable
- Debentures
- Any other payments that are not due within a year
What is equity?
This is also called the owner’s or shareholder’s equity. It’s the value that an owner of a business has left over after all of the assets were liquidated and all of the company’s debts were paid off.
To calculate equity on a balance sheet, you would use the formula below:
Stakeholders Equity = Total Assets – Total Liabilities
Shareholder equity can be either negative or positive. If positive, the company has enough assets to cover its liabilities. If negative, the company’s liabilities exceed its assets.
What does a balance sheet look like?
Using the example above, we break down and define what each of the terms means on this balance sheet.
Assets
1a. Cash
Cash and cash equivalents under the current assets section of a balance sheet represent the amount of money the company has in the bank, whether in the form of cash, savings bonds, certificates of deposit, or money invested in money market funds. It tells you how much money is available to the business immediately.
1b. Accounts Receivable (AR)
Accounts Receivable (AR) is the proceeds or payment which the company will receive from its customers who have purchased its goods & services on credit.
1c. Inventory
Inventory is the array of finished goods or goods used in production held by a company.
1d. Other Current Assets (OCA)
Other current assets (OCA) are a category of things of value that a company owns, benefits from, or uses to generate income that can be converted into cash within one business cycle.
1e. Total Current Assets
Total current assets are the aggregate amount of all cash, receivables, prepaid expenses, and inventory on an organization’s balance sheet. These assets are classified as current assets if there is an expectation that they will be converted into cash within one year.
1f. Long Term Assets
Long-term assets are those held on a company’s balance sheet for many years. These are fixed assets such as property, plant, and equipment, which can include land, machinery, buildings, fixtures, and vehicles.
1g. Accumulated Depreciation
Accumulated depreciation is the sum of all recorded depreciation on an asset to a specific date.
1h. Total Long-Term Assets
Long-Term Assets – Accumulated Depreciation
1i. Total Assets
Total assets are all the assets or items of value, a small business owns. Included in total assets are cash, accounts receivable (money owing to you), inventory, equipment, tools, etc.
Liabilities
1j. Accounts Payable
Accounts payable (AP) represents the amount that a company owes to its creditors and suppliers (also referred to as a current liability account).
1k. Income Tax Payable
It is compiled of taxes due to the government within one year. The calculation of income tax payable is according to the prevailing tax law in the company’s home country.
1l. Short Term Debt
This is a firm’s financial obligations that are expected to be paid off within a year.
1m. Prepaid Revenue
This is also called unearned revenue and unearned income – it is the money someone pays your company in advance of you doing the work.
1n. Total Current Liabilities
Total current liabilities are the sum of accounts payable, accrued liabilities, and taxes.
1o. Long Term Debt
Long Term Debt (LTD) is any amount of outstanding debt a company holds that has a maturity of 12 months or longer.
1p. Long Term Liabilities
Long-term liabilities are financial obligations of a company that are due more than one year in the future.
1q. Total Liabilities
Total liabilities are the combined debts and obligations that an individual or company owes to outside parties. Everything the company owns is classified as an asset and all amounts the company owes for future obligations are recorded as liabilities.
Equity
1r. Paid-In Capital
Paid-In Capital is the money invested by you and your shareholders
1s. Retained Earnings
Retained earnings are the accumulated portion of a business’s profits that are not distributed as dividends to shareholders
1t. Earnings
Typically, this is referring to net income or the profit for the period.
1u. Total Owner’s Equity
Owner’s Equity is defined as the proportion of the total value of a company’s assets that can be claimed by its owners (sole proprietorship or partnership) and by its shareholders (if it is a corporation).
1v. Total Liabilities and Equity
The sum of the total liabilities and equity
As we continue to mention, it is important to learn about all aspects of the business, most importantly the financial side. As an entrepreneur, gaining knowledge allows you to learn more and address issues quickly. You are presented with a snapshot of the business to understand where and how your money is being spent.
