How understanding balance sheets is a key to success

You can have the most fantastic business with a wonderful product that people are desperate to buy, but if you fail to get the financial side of things right you are doomed to fail. 

That is a simple fact of business, with those who struggle to get their heads around the numbers often among the first to hit the rocks.

Running a tight ship is the key to enjoying a profitable existence, meaning you must keep a close eye on exactly what is going out and into a business. 

With this in mind, balance sheets are likely to be your friend, as they give you the opportunity to identify exactly where your strengths and weaknesses lie.

Of course, it's not just about being able to read and understand a balance sheet, it's also important that you are able to enter the correct information on the document in the first place. 

This will ensure that any statistics, data and trends you identify as being particularly crucial are reliable and accurate.

What is a balance sheet?

A balance sheet is a record of exactly what a business has in assets and what it owes to others. 

Everything from stock and equipment to supplier debts should be included to give an overall picture of the state of a firm.

The balance sheet also reveals exactly what an organisation's cash to debt ratio is - something that is known to be of huge importance, particularly in these difficult economic times. 

If a firm is becoming too reliant on credit, the balance sheet should identify this is the case.

Why do I need one?

As well as being able to keep your finger on the pulse of operations, the balance sheet is a useful exhibit for you to showcase when it comes to trying for a bank loan or attempting to attract new investors.  

A positive and concise balance sheet should make it much easier for people to pump money into your company.

With all this in mind, what you need to make sure you can do above all else is understand your sheet. 

How do I understand a balance sheet?

It tends to be broken down into numerous columns, with these representing factors such as cash reserves, fixed assets, borrowings and debts to be call in. 

You can even prioritise certain columns if this makes it easier to evaluate.

Handily, it should give an indicator of whether it would be easy to turn certain assets into cash, i.e. the rate of liquidity a company is operating under. 

Again, this is a key issue when it comes to assessing the overall financial health of a business and where it stands at a particular moment in its development.

If you understand the balance sheet comprehensively, you will find it much easier to manage your firm and make the changes that are needed to ensure success. 

For instance, you could decide to sell assets if you need to raise cash, while you might forecast that you will eventually end up with too many long-term creditors and subsequently look to ensure some pay up in a shorter time frame.

Expert advice

Written by a chartered accountant, Lawpack's guide Understanding Accounts Made Easy shows you how to break down a Balance Sheet in a way that is easy to understand, plus it includes an example on how to create one.

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Published on: August 30, 2012

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