A Balance Sheet is a statement prepared to identify the current state of an enterprise. It is a cumulative reflection of all the actions entered into by the enterprise since birth. Hence by design, a balance sheet can be prepared for a business at any point in time. In contrast to an Income Statement, a Balance Sheet is read left to right. It has two columns – ‘what the company owns’ and ‘what the company owes’. The total on each side must always match with the other and accountants go a really long way (at times getting lost too) in ensuring this.
The side of the balance sheet containing what a company owns is called ‘assets’. It contains typically real stuff like ‘cash’ but it also contains some not so real stuff like ‘debtors’. By real I mean that which the company really has, while unreal is stuff that is legally yours, but has still not reached you and whose chances of reaching you are not 100%. We will go into further details later as we go back to these statements and study them deeper. Another term that I used for the first time is ‘debtors’ which means – money for products / services that you have already delivered / rendered, but you are yet to receive. Since it is legally your money, it is considered an asset.
The other side of the balance sheet that contains what a company owes is called ‘liabilities’. Liabilities contain items that a company needs to pay back. They contain payments outstanding to suppliers (who have supplied raw materials) and also borrowed money that needs to be repaid (loans taken from banks, financial institutions, etc). One interesting item which appears under liabilities is ‘shareholders money’! It’s not surprising that every entrepreneur questions why this is a liability. This arises because of the fundamental flaw of the entrepreneur in not separating themselves from the enterprise. This is perhaps the first instance where this thought occurs to the entrepreneur. Is that why so many entrepreneurs refrain from learning to read balance sheets? J The reason why this appears as a liability is because; it is money that the company owes to its owners. The company is different from its owners! Yes, it is. It should be if you want to allow the business to grow.
A Balance Sheet is a statement that is referred to a lot by both bankers as well as by investors. The reason is it shows the strength of a company to withstand shocks and tribulations when turbulence rocks the enterprise. Considering the way things are in the economy across the globe, the importance of looking at the balance sheet cannot be ignored. While an early stage enterprise is not the one that needs to worry too much about creating a good looking balance sheet, there is immense use even for an entrepreneur to know if they are growing a healthy enterprise. It is something like constantly watching the impact of your eating and exercising habits; invariably you will be able to predict how healthy you will be in the future.