Balance Sheet versus P&L Statement
Your balance sheet will tell you a different cash flow story, compared to your profit and loss statement. The error many people make is to focus on their businesses profit and loss statement to the exclusion of all else. It’s a potentially fatal mistake because healthy profits can mask a cash flow crisis. Generally, profit and loss statements do not contain the information required to make an adequate cash flow projection. To get a better understanding of your business cash flow, you must start with a properly structured balance sheet that contains all the details, from inventory and debts to interest costs.
You must know and understand the numbers. Business owners often think that that’s what their accountant is for, but they couldn’t be more wrong. Only with a comprehensive balance sheet in hand is it possible to construct a useful cash flow budget (also known as cash flow projection). This vital document is a “best guess” at a business’ cash inflows and outflows over a period of time.
The three key sections of a balance sheet are assets, liabilities and the owner’s equity.
The Balance Sheet Equation
Essentially, a balance sheet formula is: Balance Sheet = Assets – Liabilities = Owner’s Equity
It is called a balance sheet because assets minus liabilities (net assets) must equal the owner’s equity (they must balance).
Your business assets would be items such as your cash, gym equipment, business location and inventories. Assets are all items with value or is leveraged by the business to generate income. Assets can either be current or non-current assets, the difference being the former assets are converted into cash within the next 12 months whereas the latter is not.
Liabilities are unpopular with business owners as it consists of amounts owed to other debtors, including bank overdrafts, loans payable and tax liabilities. Like assets, liabilities can also be classified as current and non-current.
Owner’s equity is the residual interest in the assets of a business after liabilities are deducted. It is the net worth of a business and equals the difference between assets and liabilities. Equity represents the amount belonging to the owner once all financial obligations have been met.
For an example on how the balance sheet is calculated, please see this post by the Government of Western Australia.