Lots of people get confused by balance sheets because they have no idea what they’re meant to represent.
Have you ever done a project? What was more important; The project milestones or the project plan?
When you compare this to financial accounts, the milestones are balance sheets and the plan is the profit and loss account.
So you can see that a balance sheet shows you where you’ve got up to. It shows you what you’ve accumulated in your business.
So why don’t they make sense to most people? Because accountants often prepare them using the wrong format.
You may have seen a balance sheet that shows; Assets minus liabilities equals Equity.
This is the most common form of balance sheet and also the most unhelpful in the 21st Century.
Here’s how we do balance sheets in the 21st Century.
Working Capital Plus Fixed Capital equals Debt plus Equity.
Think about buying your first home.
Probably looked like this:
-
Home (which equals Capital).
Paid for by:
Debt (borrowed from the banks),
Plus
Equity (contributed by you).
That’s how we do balance sheets because they make sense to the average person who has bought a home. It’s very easy for them to understand.
Think about your business for a minute:
You will have working capital (Inventory, accounts receivable, accounts payable, employee provisions etc.
You will have fixed capital (plant & equipment, motor vehicles etc).
And these will be paid for by:
-
Debt (borrowed from a bank) and
Equity (which is your wealth tied up in the business).
When you do balance sheets like this it becomes easier to understand what you’re accumulating and how you can use this to help you run your business.
