Am I rich yet? (ask your balance sheet)
Last week I talked about how your P&L tells you whether your company made a profit or a loss. (And the week before, why you should care about financial statements as a founder.) This week – we’re talking about the Balance Sheet.
I like to use a personal finance analogy in this one. You’ve probably heard of the concept of “Net Worth” – as in, rich people have “high net worth”. Net Worth is calculated as everything the person owns minus everything she owes; and the resulting number shows how wealthy she is. If Julie owns a $1M house and also has $500K in her bank account, but owes $200K in student loans, her net worth is $1.3M. Simple.
The Balance Sheet is a little bit like that, just for your business.
First, it shows your company’s Assets – most importantly Cash, as well as money that customers owe you (Receivables) and, depending on your business, also Inventory and Equipment. Cash is whatever is sitting in the bank account, Receivables are not yet sitting in the bank account but hopefully will be soon, Inventory is the stuff in your warehouse, and Equipment is things like laptops, sewing machines or, I don’t know, X-ray machines.
Total Assets are therefore everything the company owns, equivalent to Julie’s $1M house plus $500K in her bank account.
Next up: Liabilities, aka everything that your company owes. Do you have any bills lying around? An invoice from your warehouse? A tax bill maybe? Did you take a loan? All that shows up in this section. That’s Julie’s $200K in student loans.
And when you subtract Total Liabilities from Total Assets, the difference is Total Equity, i.e. all the capital in your business. In an ideal world, your Total Liabilities are a lot less than your Total Assets, and this number is both big and positive. In a less ideal world, your Total Liabilities are much closer in value to your Total Assets, but the Total Equity is still a positive number. Negative Equity always spells trouble with red flags all over it, but exactly what kind of trouble depends on the circumstances. (WeWork reported $2B in negative equity in its SEC filings, and we all know how well that one went.)
You may wonder: Why do we need this if we already have a P&L to show us whether a company is making money? Good question.
Using Julie’s example to answer that, a P&L would show me that Julie made $10K last month. The Balance Sheet shows me the total, cumulative value of $1.3M.
Both very different and, in the context of running a business, both very important.
Next week – Statement of Cash Flows.
Love and you know what,
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