How to Read and Interpret a Balance Sheet – Part 4

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A quick recap.

I started the series with a useful way to make sense of a balance sheet which is looking at the trend of numbers over the years presented. This means comparing the movement of numbers between the period under review and the prior period and asking why there are any significant movements. I shared my insights on what assets are. Then we looked at liabilities – I talked about why they are presented as those payable within a year and those payable after a year. If you’d like to know more, listen to episodes 25-27.

Now, I will explain how you can interpret equity. But first, a quick 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.

So, what is Equity? - I define it as what your business is worth. The value of your business.

So, we’ve looked at what you own – which are assets. We’ve also talked about what you owe which are liabilities (recall that this can either be that - you need to pay back within a year or you can pay back after a year). When it’s the former, we say they are current liabilities. When it’s the latter, we say they are long-term liabilities.

Recall our example of the six-year-old in episode 25? In that example, our little girl had a lemonade business. Assuming she now has 3 lemonade jars which she is using to make the lemonade drinks. And each jar costs $500. The 3 jars will therefore be $1500. If she has cash in the bank of say $500. That’s $2000 of what she owns. That’s her assets.

If on the other hand, she needs to pay $100 to a vendor that supplies her sugar. Also, if on one of the jars, the vendor agreed that she can pay in 2 years. Remember the cost of a jar is $500. That’s $600 in total of what she owes. $100 in current liabilities and $500 in long-term liabilities.

If all these are presented in her business balance sheet, you would want to deduct the $600 of total liabilities from the $2000 we calculated that she owns as assets. This would give us $1400. Now, that’s what her business is worth according to her business books. This means according to her financial accounting records. This is not necessarily what her business is worth in the market which is calculated differently. But, as our focus here is understanding balance sheet, I'm hoping you do get the picture?

Now, that $1400 we just calculated is her equity.

In the balance sheet, this is usually presented in the form of the owner’s money brought into the business and any profits or losses the business has accumulated over time are then added to it. But what it essentially means is what I just described.

Stay tuned and 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”.