The Typical balance sheet:
Typically, a Balance Sheet is divided into three main parts:
1. Assets: Current assets are those that can be converted into cash within one year. They typically include
cash, stocks, accounts receivable, prepaid expenses, and inventory. Fixed assets are tangible assets that
are for long-term use, such as equipment, machinery, vehicles, land and buildings, furniture and fixtures,
and leasehold improvements. Many other assets don’t fit within either of these categories so most
balance sheets include an “other assets” category for these items — typically things like long-term
investment property, life insurance cash value, and compensation due from employees.
2. Liabilities: Current liabilities are business obligations due within one year. These typically include
short-term notes payable (including lines of credit), current maturities of long-term debt, accounts
payable, accrued payroll and other expenses, and taxes payable. Long-term liabilities are business
obligations that are due outside of one year, such as any bank debt or shareholder loans with maturities
longer than one year.
3. Owner’s equity: This is the sum of all shareholder money invested in the business and accumulated
business profits. Owner’s equity includes common stock, retained earnings, and paid-in-capital.
How to Use the Balance Sheet
Your balance sheet can provide a wealth of useful information to help improve financial management. For
example, you can determine your company’s net worth by subtracting your balance sheet liabilities from
your assets, as noted above.
Perhaps the most useful aspect of your balance sheet is its ability to alert you to upcoming cash flow
shortages. After a highly profitable month or quarter, for example, business owners sometimes get lulled
into a sense of financial complacency if they don’t consider the impact of upcoming expenses on their
cash flow.
There are two easy-to-figure ratios that can be computed from the balance sheet to help determine
whether your company will have sufficient cash flow to meet current financial obligations:
- Current ratio: This measures liquidity to show whether your company has enough current (i.e., liquid)
assets on hand to pay bills on-time and run operations effectively. It is expressed as the number of times
current assets exceed current liabilities. The higher the current ratio, the better. A current ratio of 2:1 is
generally considered acceptable for inventory-carrying businesses, although industry standards can vary
widely. The acceptable current ratio for a retail business, for example, is different from that of a
manufacturer. The formula: Current Assets / Current Liabilities - Quick ratio: This ratio is similar to the current ratio but excludes inventory. A quick ratio of 1.5:1 is
generally desirable for non-inventory-carrying businesses, but—just as with current ratios—desirable
quick ratios differ from industry to industry.
The formula: Current Assets – Inventory / Current Liabilities
Knowing your industry’s standards is an important part of effectively evaluating your business’s balance
sheet. Using the balance sheet included in your industry’s report, you can calculate the current ratio and
quick ratio that are desirable for your business type, to get a better sense of how your own business’s
ratios stack up.
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