Is a balance sheet important? What is its purpose?
Questions? We have answers.
A balance sheet is a critical part of knowing your personal and/or business' financial health.
According to CFC Relationship Manager Pat Shields, "Balance sheets help you see the big picture - net worth, how much money you have, and where it's kept. They're also an essential part for securing a loan, so you need to know your way around one."
What is a balance sheet?
A balance sheet gives a snapshot of an individual's or a business' financials at a specific point in time. "It shows what you own (assets), what you owe (liabilities) and your net worth, also referred to as owner's equity when referencing a business," says Shields.
Overall, it reveals your financial health. Along with the income statement and cash flow statement, which we'll cover in subsequent articles, the balance sheet is one of the three main financial statements. Because a balance sheet summarizes finances, it is also referred to as the statement of financial position.
"It's important to think of your balance sheet as a living document," says Shields. Businesses should make updates more frequently (quarterly for example) while individuals could update annually or semi-annually. Be proactive with your financial statements instead of waiting until you need them for a loan."
What is owned, owed and left over.
As Shields mentions, the balance sheet communicates what you own, what you owe and what is left over. Let's walk through each aspect, one at a time.
Assets can be broken down into two categories: current and long-term. Compartmentalizing assets, as well as liabilities, paints a complete picture of your financial situation.
Current assets are assets that can easily be converted to cash within a year or less. Shields breaks down assets even further into these accounts:
- Cash and cash equivalents: These are your most liquid assets, including cash, checks and money stored in your checking and savings accounts
- Investments that can be sold within a year including stocks, bonds, mutual funds, and other marketable securities
- Accounts receivable: Money that others owe you for your goods or services such as custom farm work, livestock or sold grain
- Inventory: Livestock or grain for sale
- Prepaid expenses: Things of value that you've already paid for- your land or pasture rent, land prep costs, pre-paid seed, fertilizer, or feed
"Long-term assets," says Shields, "won't be converted to cash within a year."
They can be further broken down into:
- Farm or ranch land, buildings, corrals, equipment, vehicles, and breeding livestock
- Long-term securities: Investments that can't be sold within one year
- Retirement Account
Liabilities, what is owed, can also be categorized as current and long-term.
Shields explains, "Liabilities are money owed to others, including your recurring expenses, loan repayments and other forms of debt."
Current liabilities are obligations that are due and payable within one year.
- Interest that has accrued as of the date of the balance sheet.
- Accounts payable that are owed to others.
- Short-term operating loans.
- The principal portion of the longer-term debt that will be due within the year.
Long-term liabilities are obligations that are not payable in the current year.
- Breeding livestock
- Farm machinery and equipment
- Farm or ranch land loans
- Home mortgage
- Student loans
- Loans against retirement accounts
- Other debts owed against investments or businesses
Net Worth, or Owners Equity, is one of the most important (and underrated) lines in your balance sheet.
Net worth is: Assets – Liabilities = Net Worth.
For an individual it reveals the overall financial situation, essentially the icing on the cake known as the balance sheet. Shields explains, "One might have two million dollars' worth of assets BUT if those assets are overleveraged bringing your net worth in the red, the net worth calculation will show the correct financial position."
Owner's equity (or shareholder's equity if business is structured as an LLC) is calculated in the same manner as net worth. The answer is simply given a different name.
Worth a second look
Once you have created your balance sheet, don't stop there.
"Remember to update on a regular basis and use your sheet to its fullest potential," recommends Shields. For example, you can compare current assets to liabilities to make sure you can meet upcoming payments. You can also glean a lot of information about your growth (or lack thereof) by comparing current balance sheets to previous ones to examine how your finances have changed over time.
With a better picture of your overall financial situation, does a land or livestock purchase, or maybe an improvement loan, fit into that picture? If so, give your friends at Capital Farm Credit a call.