According to Bob Sloan, S3 founder, the balance sheet is one of the most important tools that an organization has for understanding its financial outlook. Business leaders and investors alike benefit from knowing what elements a balance sheet contains, and how this information can be utilized. When read correctly, a balance sheet can provide insights into how the company might proceed, keeping its financial interests front and center.
The task of reading the balance sheet correctly is not necessarily a simple one, however. For those who have never spent much time looking at balance sheets, the documents can seem overwhelming or confusing. Bob Sloan, S3 founder, offers a few tips for those who are new to balance sheets, in the paragraphs that follow.
Bob Sloan, S3 Founder: Tips for Reading Your Company’s Balance Sheet
Bob Sloan, S3 founder, offers the following balance sheet insights:
- First and foremost, simply make sure that you take the time to regularly read your organizations’ financial reports, including the balance sheet. The more time you spend with these documents, the better you will grasp the layout and the terminology. Remember that these documents are actually designed to be understandable and easy to read, even by non-finance professionals.
- Note that balance sheets are “permanent”—that is, that the account balances roll on from one year to the next. The closing balance from last year automatically becomes the opening balance for this year. Revenue and expense accounts are different; these are reset to zero at the start of each year. So, if there are unpaid accounts payable at the end of one fiscal year, they’ll roll over—and remain liabilities—until they are paid with the next year’s income.
- Bob Sloan, S3 founder, says it is important to understand how the daily operations of the business affect the balance sheet. The balance sheet is really a snapshot into the organization’s “lifetime” result—accumulated surplus or deficit—at a given point in time. The year’s revenues contribute to a surplus, and the year’s expenses reduce it, or cause a deficit. If the year is going well, it is fair to assume that daily operational activities are increasing revenues. If the year is going poorly, it may be time to correct some of those daily practices.
- When studying the balance sheet, it is important to go beyond the cash account, advises Bob Sloan, S3 founder. It is probably true that most transactions are going to go through the bank as checking account charges or deposits. Nevertheless, it is not enough to just look at the operating statement and the bank balance. Your accounts receivable and payable will have accounts with some transactions that are still being processed, or remain in progress.
- It is important to understand what all of the balance sheet terminology means—and in particular, it helps to know what to make of the word “current.” An item that is current is simply one that can be converted to cash within the next fiscal year. Something that is not current has a longer lifetime. A long-term liability is one that is not due for more than a year; a long-term asset is one that you will not be able to convert to cash within a year.
- Another term that is helpful to know is working capital. When the balance sheet references working capital, it is referring to current assets minus current liabilities. This figure basically represents what your company is able to do—to what extent it is able to carry on—in the short term, and as such it is an important value to understand.
- Bob Sloan, S3 founder, goes on to note that capital assets and depreciation policy affect the company’s financial position. A capital asset is any valuable item that your organization will own for a year or more. Buildings, land, and machinery are some common examples. Depreciation is a related concept—an accounting mechanism that allows you to spread the value of these assets over the estimated years in which you will own them. This requires some informed speculation, but is necessary for properly understanding a balance sheet.
- Non-profit organizations and charities may have some special cases on their balance sheets, including deferred revenues. These may include sponsorships or grants that have been pledged or are expected to arrive in the coming year. Ideally, this money will be sitting in the bank, so to speak, until it is actually delivered to you; if you are already spending these promised monies in expenses, it is probably indicative of poor financial health, overall.
Balance sheets are important tools—but reading them takes some skill. Bob Sloan, S3 founder, encourages company owners and investors alike to study up on their balance sheet acumen!