Step-by-Step Balance Sheet Tutorial for Entrepreneurs and Business Owners

Hi, I'm Evan Carmichael, and today I wanted to talk about a topic that a lot of entrepreneurs are scared about but shouldn't be, and that's your balance sheet. Many entrepreneurs know a balance sheet is something their accountant gives them at the end of the year, but they don't really know how to use it to make important business decisions. So in this video, I wanted to quickly talk about what a balance sheet is, what the elements are, and then give you some tips and strategies on how you can use the information in your balance sheet to run your business, potentially raise money for your business, and also sell your business. Here we go! To quickly explain what a balance sheet is, I've loaded my Simply Accounting Enterprise software, and you can go to Reports, click on Financials, open over to balance sheet, and this will help me prepare a balance sheet for the company. This is a construction company here, and there is the balance sheet. So the balance sheet will basically tell you what your business owns, what it owes to other people, and then what you as a business owner actually have in the business that's left over. So if you look at the assets here— assets is what your company will own. The liabilities are going to be what you owe to other people. And then the equity is going to be what you as the entrepreneur will own in the actual business. So the formula is always assets equals liabilities plus equity. Or if you think about another way, the assets, what your company owns, minus the liabilities, what you owe, is what you end up with as your equity in the company. Hopefully that's a lot of money. So I want to quickly just touch base on what each category is so you have an understanding. Under assets, you can look at the first category here is total current assets, and these are assets that are either cash or can be converted into cash really quickly. So you can see here, cash is here, and then usually the biggest one in the current assets are receivables. So accounts receivables are money that's basically owed to you You've either invoiced them and you're waiting on payment. It could be 30 days or 60 days or 90 days, and you're waiting to get paid. So hopefully that'll be converted pretty quickly. Inventory assets is the second category, and these are items that you have that hopefully can be converted quickly into cash if you need it. So if we look at what they have here, we've got drywall, hardware, lumber, roofing, other. So it's a construction company, that would make sense. If they really needed to generate cash, they could probably sell this and, and make some money from it. The next category are capital assets, and these are items that you cannot convert into cash very easily but are still worth a lot of money. So you can see on this balance sheet here that they've got a lot of capital assets. So if you look at that, you'll see things like furniture, equipment, vehicles, computers, building, land. So all things that have value, but it's hard to convert into money if they really need to do it quickly. And then the last category are other non-current assets, and these are things like goodwill, or if you have a patent that's potentially worth a lot of money, you would filter it here under non-current assets. The next side is liabilities, and so this is going to be what you owe as a company. Again, it's going to be divided into current liabilities and long-term liabilities. So for current liabilities, this is money that you basically will owe within the next year. So it could be accounts payable, so something that you've bought that you haven't paid off yet, credit card debt, bank loans, bank advances, corporate taxes, basically things that you need to pay off within the next year. Long-term liabilities is money that you owe to other people or other companies, but that aren't due until beyond a year. So it could be a bank loan, or mortgage, or a loan from a shareholder. Things that you have to pay off, but you don't have to pay off within the next year. So that's how much liabilities you'll have. And then the remainder is going to be the equity, and that's going to be how much you will own as the entrepreneur in the business. So again, the key thing to look at: assets is what you own, your company owns. Liabilities, what your company owes to other people or companies. And if you subtract those two, you'll end up with the equity, which is how much you have actually left in the business. So that's what a balance sheet is. Let me now show you how you can use the information in your balance sheet to run your business, raise capital for your business, and then potentially sell your business as well. 2 important numbers that we can get from our balance sheet to help us run our businesses are working capital and turnover in accounts receivable. So we'll start with working capital. Working capital, you may have heard before, it is basically your current assets minus your current liabilities. So if we look at our current assets, it's $350,000 almost, minus our current liabilities of $220,000. So we've got some, some good working capital of about $130,000. What that basically means is this company can survive in the short term. So if creditors come and say, "Hey, we need our money now," or if there's a crunch that, you know, sales dry up and the company needs to pay off you know, those liabilities— they have the money to do it. If you owe a lot of money on your liabilities and you don't have money coming in, if there's a big crunch, if sales drop off, then it's going to be hard for you to raise the money to be able to pay people off. Also, being able to pay things like salaries and day-to-day expenses are a lot easier if you have good working capital. So you want to make sure that your current assets are greater than your current liabilities, and that'll help ensure that your company can survive in the short term. The second thing to look at is your accounts receivable. And a big part of your current assets here, we can see, is our accounts receivable. So for this company, you know, we have $346,000 current assets. Accounts receivable is a big chunk of that, $236,000. This could mean I'm getting money right away, or it could mean I'm not getting money for a long time. You want to look at how frequently that money comes in. So is it, you know, 30 days payable? Is it 60 days payable? Is it 90 days payable? Because if you have a lot of liabilities, if you owe people money that's coming up, you know, the bank needs their money regardless, then you have to make sure that that money is going to come in on time. The other thing you want to make sure of is that people actually pay your accounts receivable and that you're working with companies who will pay on time. So companies that, you know, don't go bankrupt or refuse to pay you, you're still showing it here as, hey, you know, I'm over $200,000. But if they don't actually end up paying you the money, then it's going to be a hard time for you to be able to run your business. So those two key numbers are really important to look at for growing your business. Again, you want to look at your working capital, so your current assets minus your current liabilities, and that'll tell you if you're able to survive in the short term with your business. And then look at your accounts receivable and see when they're due, if the money's going to be coming in on time for you to pay off what you owe other companies, and if it's likely that that money will come in based on the types of clientele that you're working with. Next up is raising capital. If you're trying to raise capital from bankers or from investors, they want to definitely take a look at your balance sheet. So you can make it as strong as you can by first making sure that there's assets to lend against. So they won't care so much about your current assets, but they want to look at your capital assets to see if there's anything that they can lend against. So especially bankers want to see that you have a lot of assets. So if you have land, or if you have a building, or if you have any furniture, equipment that has some significant value, then they're thinking, well, if they don't pay off this debt, I can take away that building, or I could take away that land and sell it, and I can make my money back. They want to have that security that you have an asset there that they can take away from you if you don't make your payments. So they want to make sure that you have those capital assets available. The other thing that they're going to want to look at is how much debt you already have. So they're going to look at your liabilities, especially the long-term liabilities, and see, do you already have bank loans? You already have a mortgage, you have loans from shareholders. If you already have a lot of liabilities and you're owing people a lot of money, it's going to be a lot harder for you to be able to raise capital because even though you have great assets, you're already maxed out and it's harder to leverage those assets even more. If you're trying to sell your business, the potential buyer is definitely going to want to look at your balance sheet. So I want to talk about a couple things they're going to want to look at. If we're looking at assets, they're going to definitely check out your current assets and look at your receivables. So your accounts receivables, they're going to want to see how big is it and do your clients have a history of paying. Like, yes, well, we have $236,000 in accounts receivable, but you know, our clients don't often pay us on time or don't pay us at all, then you're going to get that number knocked back significantly. The other thing here is inventory assets. If you carry a lot of inventory, they're going to see what is the likelihood that you're actually going to use all of this stuff in your business. And if they had to sell it for cash, if something happened and you had to get rid of, you know, your hardware, for example, could you actually sell it for $98,000? Is it worth that much? or is it worth a lot less if you're going to sell the actual hardware itself? So they're going to look at every single number on your balance sheet and start asking you questions to see if your company is actually worth the amount that you say it's worth. One last thing to look at here, we had the other non-current assets. This again is patents, goodwill. Here it's also called intangible assets. They're called intangible because it's really hard to get an actual value on it. How do you value what a patent is worth? So you might think it's worth a lot. Often buyers will say, you know, $0. I'm not giving any value assigned to that. So something to be prepared for. The other thing, if I just close this up, that a potential investor is going to look at is do you have a track record of success? So you can create a balance sheet for every year that you've been in business, and hopefully you've been around for a little bit. And they're going to want to see that you've grown the business so that you've, you've gained assets and that you've gained in your equity. So they can see that your business is growing, you're acquiring more assets. It could be land and buildings and that kind of stuff, more equipment to grow the business. And also, it's great that you've acquired more assets, but they want to see that you're reducing your liabilities, or at least your equity is growing faster than your liabilities. So if your assets are going up, then either your liabilities or your equity have to be going up. So hopefully it's the equity side, and that's what your, your own value in the business is, instead of you financing the growth by taking on tons of debt. A new owner doesn't want to come into a business and have to pay off huge amounts of debt. So they're typically going to want to look at 3 years or 5 years growth if you have that. If you don't have that, then as much as you can. But definitely be prepared with your balance sheets because it makes you look a lot more professional, makes you look like a a serious business person, and it increases the chances that you'll be able to sell your business and hopefully get a good price for it. Thank you for joining me for this video. I hope you enjoyed and it gave you some more information about what a balance sheet is and how you can use it to make important decisions for your business. If you did enjoy the video, please give it a thumbs up below. I'd also love to hear your thoughts and feedback if you want to leave a comment, and stay tuned for the next episode.