As an IT executive, how many times have you received a copy of your company’s balance sheet, only to toss it in the trash or file it away unread? Don’t let it happen again. That balance sheet is the window to your company’s financial soul, and through it, you can not only find out how well your enterprise is fiscally doing, but you can also use that financial statement to gauge the success of your company’s IT efforts.
As one of the most common financial statements used by businesses, a balance sheet can yield financial calculations that will give you a better understanding of your company and the factors affecting IT functions.
Besides communicating the state of the business, the balance sheet—also called a statement of financial position—is a formal document that follows a standard accounting format showing the same categories of assets and liabilities regardless of your business.
The information gleaned from the preparation and analysis of a balance sheet can be the IT and financial management tool that determines a business’ success or failure.
The IT connection
Balance sheets present the condition of an enterprise at one given point in time. IT professionals will lose the opportunity to gather valuable information if a timely comparison of the progress and trends of a business are not regularly evaluated and compared by examining balance sheets for current and previous time periods.
The balance sheet is a summary of what the business owns (assets), what it owes (liabilities), and its net worth. It is prepared at the close of an accounting period such as month-end, quarter-end, or year-end.
With the data in your balance sheet, you can calculate liquidity and leverage ratios as well as the company’s overall financial flexibility.
Over time, a comparison of balance sheets can illustrate the financial health of the business. In conjunction with other financial reports, such as income and cash-flow statements, the balance sheet forms the basis for a more sophisticated business analysis.
Analyzing a balance sheet
The key to understanding a balance sheet lies in this simple formula:
All balance sheets must follow the same format: If it is in two columns, assets are on the left, liabilities are on the right, and net worth is beneath liabilities. If it is in one column, assets are listed first, followed by liabilities and net worth.
All balance sheets show the same categories. Assets are categorized as current, fixed (long-term), and other. Assets are arranged in the order of how quickly they can be converted into cash. Turning assets into cash is called liquidity.
Current assets include:
- Stocks and bonds
- Accounts receivable
- Prepaid expenses
- Anything else that can be converted into cash within one year or during the normal course of business
Fixed assets are also known as long-term assets. These produce revenues and are distinguished from current assets by their longevity.
Fixed assets include:
- Furniture and fixtures
- Motor vehicles
- Buildings and land
- Building improvements (or leasehold improvements, if you rent)
- Production machinery
- Any other items with an expected business life that can be measured in years
All fixed assets (except land) are shown on the balance sheet at original (or historic) cost less any depreciation. Subtracting depreciation is the conservative and required practice to indicate the reduction of the value of the asset. A specified amount (percentage) is subtracted from the original purchase price to reflect the wear and tear on the asset and to theoretically provide the means for replacing it.
The two types of liabilities are current and long-term. Liabilities are arranged on the balance sheet in the order of how soon they must be repaid. For example, accounts payable will appear first as they are generally paid within 30 days. Notes payable are usually due within 90 days and are the second liability to appear on the balance sheet.
The formula that defines the balance sheet:
can be transposed to yield a definition of net worth:
Net worth is what remains after liabilities have been subtracted from the assets of the business.
You can use your balance sheet as the basis for financial calculations that will give you a better understanding of your company and the factors that affect IT functions. With the data in your balance sheet, you can calculate liquidity and leverage ratios. These financial ratios turn the raw financial data from the balance sheet into useful information that will enable the IT professional to manage his or her duties and make knowledgeable decisions.
Ratio analysis is a tool to uncover trends in a business or industry as well as allow the comparison between one business and its competition. An overview of the ratios a balance sheet could yield include:
- Current ratio:: Current assets divided by current liabilities
- Quick ratio:Current assets minus inventory, divided by current liabilities (also known as the acid test)
- Working capital:Current assets minus current liabilities
- Debt/Worth Ratio:Total liabilities divided by net worth
Jack Fox is Executive Director of The Accounting Guild in Las Vegas. Fox has been assisting thousands of accountants and IT consultants in building their own successful businesses. He has also coached for effective leadership in IT functions of small to medium-sized enterprises since 1984. He is the author of five books, including the third edition of Starting and Building Your Own Accounting Business published by John Wiley & Sons.
Besides a balance sheet, what other financial statements give you a clear picture of your business’s performance? How have you used them to help plan your company’s IT functions? Post a comment below or send us an e-mail .Assets: Anything that a business owns that has monetary value.Accounts Payable: Debts of the business, often to suppliers, and generallypayable within 30 days.Accounts Receivable: An amount owed to the business, usually by customers,as a result of the extension of credit.Liabilities: Debts of the business.Long-term Liabilities: Debts of a business due after a period of 12 monthsor longer.Net Worth: The stockholders’ equity in a business that is represented by thedifference between assets and liabilities.