An alarming number of small businesses fail at one basic task: Tracking inventory and assets. In a world where many small businesses fail, understanding the ins and outs of a balance sheet could make a big difference to anyone who might start (or invest in) a small business.
What Are Assets?
Assets are things you own, including equipment, furniture, vehicles or property. These assets are reflected on a balance sheet, which also includes any liabilities (or debt) and shareholder equity.
While you may be tempted to count small purchases as assets, those are considered expenses and are documented on a company income statement, rather than a balance sheet.
Assets on a balance sheet typically fall into the following four categories.
Short-Term Assets
Any assets that you intend to sell within a year count as short-term assets. So does cash on hand. Additionally, inventory, prepaid expenses (bulk orders of supplies or leased office equipment), and accounts receivable all go on a balance sheet as short-term assets.
Long-Term Assets
If you intend to own the asset for more than a year, it’s considered long-term. Land and buildings; equipment and machinery; and long-term loans are all examples of long-term assets.
There are times when you might sell a long-term asset sooner than expected; classify assets based on your business plan.
It’s important to distinguish between short-term and long-term assets since long-term assets are subject to depreciation, meaning you can reduce their value on your balance sheet each year. This more accurately reflects their worth following regular wear and tear, so you can better value what you own over time.
Intangible Assets
Intangible assets are made up of things you can’t see or touch, such as intellectual property or a sterling reputation. For instance, the true value of Coca-Cola’s likely extends far beyond its physical assets to its secret recipes and global brand recognition.
Contra Assets
As the name implies, contra assets are recorded against assets. For instance, depreciation is tracked on a balance sheet as a contra asset. Any doubtful accounts (customers who you think won’t pay their bill) may have contra assets added on their accounts to decrease the shock of a missed payment.
What Are Liabilities?
Liabilities are amounts that you owe, including any liens against the assets that you own. At the most basic level, businesses that cannot meet their liabilities fail. There are two main categories for liabilities: short-term liabilities and long-term liabilities.
Short-term liabilities mainly consist of accrued expenses and accounts payable. Accrued expenses are expenses that don’t yet have a direct invoice—for instance, taxes you withhold in anticipation of paying the IRS. Accounts payable is any money owed to suppliers and vendors.
Long-term liabilities extend beyond a calendar year. These are usually things like bank loans and mortgages and the terms can vary widely.
The Relationship Between Assets and Liabilities
Assets and liabilities are often highly intertwined on a company balance sheet. If you borrow money to purchase a property, for example, you add two things to your balance sheet: the property as an asset and the mortgage as a liability. While inventory is an asset, the money spent to acquire that inventory usually goes onto the liability side of the balance sheet as accounts payable.
While equity (a common measure for corporate value) comes down to assets minus liabilities, there’s no perfect balance for a balance sheet. These days, more investors appreciate intellectual property, which is harder to estimate and capture on a balance sheet, for example.
For business owners who derive a large part of their personal wealth from their companies, understanding your firm’s equity and balance sheet can be an essential part of financial planning. This is also true for anyone looking to invest in a small or private business.
If you have questions about reading or analyzing a business balance sheet, set up a time to discuss with a Bogart Wealth Financial Advisor.
