Understanding And Using The Balance Sheet To Run Your Business

How To Track The Health Of Your Business Using The Balance Sheet

The Balance Sheet is a vital financial statement for business management and one of those statutorily required to be presented to the members of a public limited company at their annual general meeting. It is designed to present a performance scorecard which shows the position of the business as at the date to which it is prepared.

The Purpose
The balance sheet shows, in a logical format, the assets owned by the business, its liabilities to other parties and the shareholders' equity. This statement is logical: the shareholders' funds are applied in acquiring assets for the business and asset acquisitions not met from this source are, necessarily, funded with borrowings and liabilities to other parties. The simple and clear equation of this relationship is: assets = liabilities + shareholders equity.

The balance sheet is a snapshot statement. Simply put, this means that it shows the position as at the stated date of the statement. This clearly highlights the state of health of the business as at that date. The balance sheets as at two dates will have to be compared to identify the specific changes that occurred in between. It is not an alternative to the Profit and Loss account: both are related and should in fact be evaluated together in assessing the performance and state of a business.

The Structure and Components
As shown earlier in the general equation, the balance sheet has two sides: (1) the assets (2) the liabilities and shareholders' equity. Both must be balanced.

Assets: Are the resources and property owned by the business. While the details of assets owned by various businesses will vary, they are broadly classified as fixed or current. Fixed assets have a long life span, usually over one year and represent investment to create the capacity for the continued operation of the business. They are therefore not meant for resale in the ordinary course of trading by the business. Fixed assets can be tangible (motor vehicles, for example) or intangible (example: goodwill). Current assets, on the other hand are generally liquid, short term assets which continue to change form in the course of the trading operations of the business (cash typically changes to stock, then possibly receivable and back to cash). Some of the asset categories include:

1. Fixed 2. Current
  • Land


  • Buildings


  • Office Equipment   


  • Machinery


  • Vehicles


  • Furniture
  • Cash


  • Receivables


  • Stocks


  • Prepayments    


  • Investments

Liabilities: These are obligations to other parties, that is, what the business owes: to suppliers, contractors, government for tax, shareholders for dividend declared but not paid, staff for due wages, utility institutions for services not paid for, banks for loans and overdrafts, debenture holders, etc. Liabilities are classified as current or long term. Current liabilities are short term obligations, usually due with one year (example: amount due to suppliers). Long term liabilities are debts and obligations with maturities exceeding one year (example: debenture). Some of the common liability items include:

1. Long term 2. Current
  • Mortgages Payable


  • Bank term loans


  • Debentures
  • Accounts payable


  • Tax payable


  • Dividend Payable


  • Overdraft

Owners' Equity: This represents the share capital contribution of the owner(s) of the business and undistributed (retained) earnings. If the business generates net profit from its operations and any part of this is not distributed as dividend to shareholders, shareholders' equity is increased by the amount of the retained profit.

Why It Matters
To run your business well, you need to understand and use the balance sheet, along with the other key statements. The individual items tell important stories about your business and its condition. More importantly, when relationships between these items are evaluated (referred to as financial ratios) or movements over periods are measured and analysed, the health and potentials of the business are shown in bold relief. You need these measurements to pilot your business. In specific terms, they highlight, among others:

  • inventory levels, whether rising or falling and if stock levels are optimum
  • liquidity of the business and whether available liquid assets can meet maturing obligations
  • whether the business can meet financial stress
  • whether accounts payable are mounting or effectively being discharged
  • If receivables are being collected as due or accumulating
  • If the business is over-investing in fixed assets to the detriment of working capital.

The balance sheet is also a key requirement by banks, lenders, investors or other parties who may wish to evaluate the business prior to entering a commitment with it.

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