In the last business plan post we did our best to explain the Income Statement in Plain English. Hopefully we didn’t sound like a “quant-jock” and cleared away the haze and confusion that can sometimes come with financial statements.
So this is why someone like myself who has started a few business, has an accounting degree he never used and loves to write might be unique qualified to bring you Business Plan Financials in Plain English. Now we get to dive into a portion that is just as important but a little more complex. This is the one that is the report of a company’s possessions, debts and capital invested – The balance sheet.
Plain English Definition of the Balance Sheet
The Balance Sheet is one of the most important financial statements of a company. It may be presented quarterly, semiannually or monthly. Think of a balance sheet like a snapshot of the company at a moment in time. There are two sides to the Balance Sheet – the left and the right. The left side provides information on what the company owns (its assets). The right side has two parts: what it owes (its liabilities), and the value of the business to its stockholders (the shareholders’ equity). They call this a Balance Sheet because the left must equal the right or “be in balance”.
Plain English Components of the Balance Sheet
I could go crazy on the types of assets, liabilities and owner equity on a balance sheet, but I won’t because I care too much about your sanity. However, if your inner accountant is calling to you, I would invite you to go here. With that disclaimer said, I am going to do my best to stay at a high level, talk in plain english and make sense of this stuff.
Assets are what you have to make stuff. Assets can be buildings and machinery. They can be patents or copyrights that provide financial advantages for their holder. You need to know that there are two major categories – Current Assets and Long Term Assets. Current assets are those assets that are usually converted to cash within one year. They usually include cash, accounts receivable and inventory. Long-term assets are, you guessed it, converted to cash past one year. They include fixed assets (e.g. buildings, equipment), depreciation and intangible assets (e.g. patents and copyrights).
Liabilities are what a company owes to outside parties. Liabilities are generally broken down into two major categories – current liabilities and long-term liabilities. Current liabilities are those obligations that are usually paid within the year, such as accounts payable, interest on long-term debts, taxes payable, and dividends payable. Long-term liabilities concern those liability of a period greater than one year. It usually refers to loans a company takes out.
Owners or Shareholders Equity is a very fancy way of showing the value of a business to its owners after all of its obligations have been met. Owners equity generally reflects the amount of capital the owners invested plus any profits that the company generates that are subsequently reinvested in the company. This reinvested income is called retained earnings.
Plain English Explanation of Why People Need to Review the Balance Sheet
People want to review the balance sheet to examine if the firm can meet its financial obligations, if it has taken on too much debt, what assets it has bought with the money it has and how much, if any, has been invested in the company.
The balance sheet provides a person with insight into a firm’s future performance. The income statement is about how well or badly we have done and the balance sheet is snapshot that looks toward the future.
NEXT TIME: The Cash Flow Statement in Plain EnglishGoogle+