The Benefits of Using a Balance Sheet
Also called a statement of financial position, the balance sheet is a snapshot of what you own (your assets) and what you owe (your liabilities) at a point in time. The difference—shareholders equity—is your company’s net worth. Diligently tracking your company’s finances can help you identify potential issues before they turn into major problems. In fact, 29 percent of small businesses fail because they run out of cash, an issue that may be easily managed or avoided through proper reporting.
Ultimately, a balance sheet provides the information you need to sustain and grow your business over time. Creating one doesn’t need to be complicated, and its benefits can be far-reaching. Let’s explore three notable benefits in this post.
1. It Determines Risk and Return
A balance sheet succinctly lists your assets and liabilities in one place. Current and long-term assets reflect your ability to generate cash and sustain operations, while short- and long-term debts prioritize your business’s financial obligations. Ideally, you have more assets on your balance sheet than liabilities, indicating positive net worth.
Comparing your current assets to current liabilities determines whether your business can cover its short-term obligations. If your current liabilities exceed your cash balance, your business may require additional working capital, prompting you to seek funding from outside sources. However, a balance sheet can also show you when your debt levels are unsustainable. If you have too much debt on your balance sheet, you may be at risk of defaulting on debt payments, or worse yet, bankruptcy.
2. It Can Be Used to Secure Loans and Other Capital
Your balance sheet allows people outside of your company to quickly understand its financial condition. Most lenders require a balance sheet to determine a business’s financial health and creditworthiness. Additionally, potential investors may use it to understand where their funding will go and when they can expect to be repaid.
When updated over time, your balance sheet effectively shows your ability to collect payments and repay debts. A track record of managing your assets and liabilities responsibly indicates to creditors and investors that their funding will be put to good use and returned in a timely manner.
3. It Provides Helpful Ratios
Ratios are often used in financial statement analysis to indicate a company’s operational efficiency, liquidity, profitability, and solvency. These ratios are particularly helpful when assessing the long-term sustainability of a business, and many are determined by a company’s balance sheet accounts.
For example, the ratios derived from your balance sheet can reveal your company’s overall capital structure, how long it takes to sell inventory, and the average number of days it typically takes to collect payments from your customers. This information can be helpful for identifying trends over time while allowing you to see how your company’s finances and operational efficiency compare to the competition.
Preparing and understanding your company’s financial statements is one of the most important steps you can take as a business owner. The balance sheet is particularly helpful in that it keeps both you and your stakeholders informed of your financial standing. Keeping this information updated over time can help you make better management decisions and improve your business’s operational efficiency, borrowing habits, and overall financial health.
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