How to Read and Interpret a Balance Sheet – Part 3

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So today, I wanted to go back to why understanding balance sheet is important for you.

You see when you want to buy a business, you want to take a quick snapshot of the balance sheet. This is so that - at least, when your professional advisers such as accountants are discussing with you, you can follow reasonably.

Even when you already have your business, it doesn’t hurt to from time to time review your business balance sheet. For example, if you are seeking a loan or line of credit, the institution that wants to give you the credit will most likely ask to review your balance sheet. You want to make sure you understand what they will be looking to see and why.

So far, we’ve looked at what assets are, and in the last episode, we looked into short-term liabilities. We’ve also done a bit of introduction on long-term liabilities. I’d like to look into long-term liabilities more today. So, if you’d like to have a full picture, I encourage you to listen to episodes 25 and 26 first. Also, a reminder that I’m intentionally keeping these episodes on finance short as they are meant for non-finance businesspeople and I do appreciate it can be a lot to take in from that perspective.

Now, when the arrangement is such that you can pay the vendor after one year, the liabilities are usually called ‘Long-term Liabilities’. I define them as the money you owe which you are not expected to pay back until after one year.  Generally, the more of your liabilities in the long term, the better your business will look.

This is why – if you bought a refrigerator to sell drinks. Let’s say you bought it for $5,000. Let’s also say you can make gains of $1,000 annually from using it to sell the drinks. If the seller of the refrigerator demands payment immediately or within your first year of using it, you are immediately looking for $5,000 to pay. But if the seller allows you to pay say in 2 years, you would have $2,000 from using the refrigerator and you would only need to look for $3,000 extra. Chances are in that time; you would have even been able to use the $2,000 many times in the business to generate more cash. So, effectively, you’ve gained the value of time. And that’s why institutions reviewing your balance sheet will most likely look favourably at your balance sheet if more items are in long-term liabilities as opposed to short-term or what we call current liabilities.

I’ll stop here this time and on next episode, we’ll continue the series by looking at another component of balance sheet which is equity.

Till then, keep connecting.

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”.