A few months back I talked about the Profit & Loss Statement in a blog about allowable write-offs. This time around I’m looking to explore the second major statement for many companies – the Balance Sheet.
Proprietorships and partnerships are only required by law to produce a Profit & Loss Statement. As mentioned, the bottom line is added to and impacts the personal income of the owner or owners. This in turn affects the taxes that they will ultimately pay. Corporations, however, must also submit a Balance Sheet to Revenue Canada at the end of the fiscal year. This is mandatory. Proprietorships and partnerships can generate and make use of the Balance Sheet but, in their case, it is not a mandatory requirement – from a tax standpoint.
So what is the Balance Sheet all about anyway? If the Profit & Loss Statement is about revenues and expenses leading to a bottom line across a period of time, the Balance Sheet is about the net worth of a business at a given moment in time. A snapshot of the financial health of the business if you would. This need not only occur at year end but can be generated whenever and as often as necessary whether it be monthly, quarterly or any other time frame.
The Balance Sheet is divided into 3 major sections – assets, liabilities and shareholder or owner equity. In its simplest terms the assets are what the business owns expressed in dollar values, the liabilities are what the business owes to creditors – again expressed in dollar values and equity is what remains which is the net worth of the business to shareholders and/or owners. To sum it up – assets minus liabilities equals equity.
In a healthy situation the net value of the assets are greater than the value of the liabilities which leaves the equity balance as a positive value. In other words, if the company were to fold immediately, the shareholders or owners could expect a positive return upon collapse. Is the opposite possible? Very much so. Does this mean the company is in trouble or in danger of collapse? Not necessarily provided that the plan and mechanisms are in place to turn it all around.
So what are assets anyway? Assets can be current such as cash and accounts receivable or non-current such as buildings, land, equipment, vehicles, etc. All of these are of value to the company. Current in this context just means cash or readily converted into cash.
Liabilities on the other hand include such things as accounts payable, loans, lines of credit, credit card balances, payroll owing, taxes owing, etc.
The equity of the business is usually divided into capital stock and retained earnings.
So why is it important to pay attention to the Balance Sheet along with the Profit & Loss Statement and the myriad other statements available from a properly maintained set of books? Besides the requirements imposed by Revenue Canada, smart owners and managers will use the numbers provided by the statements to manage their businesses. They will be able to monitor trends, target growth, manage cash flow and short circuit any problems before they arise or do very much damage.
Investors, lenders, shareholders, the accountant and other parties may also need to see proper statements like the Balance Sheet in order to determine their relationship and future with the business.
By doing comparisons across time of a number of Balance Sheets, the changes in the position of the company can be viewed and assessed and reacted to. This is also vital when it comes to planning for the future.
Coming up with an accurate and timely Balance Sheet involves the dedicated input of full cycle accounting by the bookkeepers – also covered in a previous blog. For our clients, this is what we do. As usual, I would be happy to review the Balance Sheet along with all the financials of our clients at any time. You need only ask.
Enjoy your summer.