How to Read and Interpret a Balance Sheet – Part 1

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Do you find accounting intimidating? Or even boring? But then, hardly can we do any business without accounting. And of course, you can hire the right staff to do the technical bit for you. But, you may still find it beneficial to at least understand how to interpret some accounting reports or shall we say financial reports. Believe it or not, it’s far more approachable than you think. The next 8 series of this blog will be on how to interpret financial reports. This is part 1 so here you go.

Why should you care to know how to read and interpret a balance sheet? Well, it is useful for you in communicating your financial results. So, next time you have a discussion with your accountant, you can save some time with the knowledge you already gained here. Hopefully!

So, I just downloaded a proforma small business balance sheet from Google. Now, a proforma is a typical example of an item or an imitation of something. And I’m going to use it to explain the items on it as I understand them.  I won’t be dwelling on the numbers because that's better if I am showing. But since this is a blog (with an audio version), I'm just going to try to explain it like I was explaining it to a six-year-old.

Now, when you have a balance sheet for your business, you're usually going to see typically assets, liabilities, and equity. Let’s start with assets. What are assets? They are anything you own. So, I will tell a six-year-old that assets can be what she owns and can have for a short time or for a long time. If her mom gave her $10 for a birthday gift to buy whatever she likes in a snack shop, that’s cash she has for a short time until she gets to the snack shop. If she buys sugar with the $10 to make drinks for her friends during summer, the sugar becomes another item she owns until summer which a businessperson can call inventory. If her mom gave her a big lemonade jar to make lemonade drinks for her friends during summer, that’s what she can have for a long time, and we call that long-term assets or fixed assets. She’ll probably have the lemonade jar set up in her mom’s kitchen or in her garage and because it’s so big, she can’t move it around easily. So, we say it is fixed assets. Also, the jar will produce drinks for her friends later in summer so it’s going to be working for her. You get the drift?

So, to a business owner now, your assets are divided into current assets (what you own for a short time) and fixed assets (what will produce value for your business and what you own for a long time and you can’t easily move around).

Before we move to other items such as liabilities, I usually like to say the starting point for interpreting should be understanding comparatives. Assuming it's not your first year of business, you will have previous period numbers. For example, if you were looking at 2023 balance sheet, just beside it in another column, usually you will see 2022 numbers. The first beneficial thing is to look at each row of the balance sheet and quickly compare what you have in the current period with previous period. In our example, if your total assets in 2023 were $50,000 and $60,000 in 2022, then you need to ask your accountant – ‘why did it reduce?’ and there should be a business reason for that.  Then you can compare the explanation with what you intended to do - was that the goal for your business?  Ideally, what you want is for your assets to be increasing if you're growing your business, but there are situations where assets may reduce. The important thing is for you to understand any kind of movement.

I must admit that can be a lot to take for a ‘no-numbers person’. So, I will stop there for now and we will continue with part 2 on next episode. Until then, let’s continue to learn together and be encouraged to keep on connecting.

Cheerio!

This blog is about personal development for entrepreneurs based on the principles of fairness, compassion, and commitment. This includes the practice of 'speaking' positive affirmations, which can be a powerful tool to support self-development. Hopefully, you’re impacted positively in some ways. As we all know, personal circumstances are quite different. So, I encourage you to apply the lessons in line with your own context. Do continue to “Hola” to connect with people and remember “Let's continue to learn together and be encouraged to keep on connecting”.