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by The Bean Team on September 18, 2018
4.5 MIN READ
We review a lot of books here at FA Bean Counters, and time and again we see a common mistake when it comes to balance sheets: not all assets and liabilities are listed. While this might not seem like that big of a deal, keeping an accurate, up-to-date balance sheet is essential to fully understanding the financial health of your business. And as a business owner, having a comprehensive, accurate understanding of your business is essential to productively and profitably moving it forward.
A Picture of Health
Balance sheets are primarily used to paint a clear picture of your business’s financial health. Your balance sheet tracks the assets and liabilities of your business, and is one of three major financial statements along with your income statement and your statement of cash flows. It offers a holistic perspective on the financial state of your business, specifically detailing what is owned versus what is owed.
In contrast, an income statement represents a snapshot in time, showing revenue that has been earned and expenses that have been paid, but offering no information on what is owed. Business owners who rely too heavily on their income statements can find themselves in disastrous spending situations that ultimately cripple cash flow.
By looking instead to the more holistic balance sheet, business owners can identify potential issues early and implement tailored strategies appropriately.
What Goes On My Balance Sheet?
Assets and liabilities are the fundamental elements of your business’s financial position. They're reported on your balance sheet, with assets on one side and liabilities on the other. The difference between the two (the “book value”) represents your equity in the company—what you would walk away with if you sold all your assets and paid off all your debts.
Assets are everything your business owns, and include things like bank accounts, accounts receivable, notes receivable, and fixed assets. Liabilities are everything your business owes, such as credit cards, notes payable, loans, and accounts payable.
And when we say everything, we mean everything. This includes any sundry accounts, which are assets of your business and therefore must be tracked, even if you only receive income on a quarterly basis and most, if not all, of the money is immediately transferred out of the account.
Similarly, any loans, even those you have personally guaranteed, must be listed as liabilities if they are in the name of your business.
Types of Assets and Liabilities
There is more than one kind of asset and liability. When preparing your balance sheet, assets and liabilities must be separated out into different categories. The main categories of assets are: current assets (which includes liquid assets), fixed (or non-current) assets, and other (or non-liquid) assets.
Liquid assets are considered current assets, and are listed under current assets on a balance sheet, with the main difference between the two being period of liquidity. Liquid assets are considered “more liquid” than current assets in the sense that liquid assets can be converted into cash in an even shorter amount of time than current assets, typically within 90 days.
Liquid assets—which are assumed can be converted into cash at any point in time—include current assets like money in bank accounts, bonds, and certificates of deposit. Any other sources that can be quickly translated into cash without losing value under this category are also considered liquid assets.
Current assets include cash and cash equivalents, and anything that can be reasonably converted into cash within one year (versus the much shorter 90 period of liquidity of liquid assets). Examples of current assets include short-term investments, accounts receivable, and, of course, cash and cash equivalents
Current assets are clearly separated out on a balance sheet in order of liquidity. For example, cash and cash equivalents are the most liquid and are therefore typically listed first.
Fixed assets are tangible, non-current assets used in business operations. They include a business’s property, plant, and equipment (PP&E). This includes real estate, buildings, offices, vehicles (if the vehicle was purchased using your business name and EIN), and other tangible things a business uses to conduct operations.
Some people consider things like office furniture and technology (such as computers) fixed assets, but these items need not be added as assets if under the value of $2,500. The IRS increased the de minimis safe harbor limitation from $500 to $2,500 per invoice or item for taxpayers without applicable financial statements and for costs incurred during taxable years beginning on or after January 1, 2016.
The “other assets” category is used to keep track of non-liquid assets you don’t expect to convert to cash within the next year. A security deposit that your landlord will possess for the duration of your lease term is a common example of a non-liquid asset.
Just as there are different categories of assets, there are different categories of liabilities. Categorizing your liabilities separately helps you see what expenses you have to deal with now versus in the future. The two main categories of liability are current and long-term.
Current liabilities (also known as short-term liabilities) represent any debts or obligations you must pay within one year. This might include accounts payable, monthly bills, and wages employees have earned but that haven’t yet been paid out. Current liabilities should be closely monitored to ensure your business has enough liquidity from current assets to pay them off.
Long-term liabilities represent expenses and payments that extend beyond a year’s time, like a mortgage balance. An ongoing payment that continues more than 12 months might also be considered a long-term liability. Long-term liabilities are critical to determining a business's long-term solvency. If your business is unable to repay your long-term liabilities as they are due, then it will face a solvency crisis.
What If I Buy A Book of Business?
You may be wondering how to classify a book of business transaction on your balance sheet. When buying another advisor’s book of business, a fixed asset account must be created to hold the book of business you are purchasing. We recommend adding the selling advisor’s name to the book of business (asset) purchase for tracking purposes.
If the selling advisor agrees to finance the purchase, a liability account must be created. Every time you make a payment to the selling advisor, the liability will decrease by the amount of the principal. If there is any interest included in the payment, it can be immediately split out and expensed. Tip: have an amortization table on hand for the term of the liability.
Understanding Your Business
Properly tracking assets and liabilities gives you a comprehensive overview of the financial health of your business, and can help you better manage expenses and more easily see where your money is going.
Managing your balance sheet properly and keeping it accurate and up-to-date allows you to stay on top of each and every transaction that occurs within the operations of your business, ensuring that as the business owner, you have the most complete and accurate understanding of the overall financial health of your company.
Do you lack the time and/or expertise to regularly update your financial statements? If so, you don’t have to miss out on the benefits of agile bookkeeping. FA Bean Counters offers a simple, cost-effective way to refresh your financial statements—including your balance sheet—so you’re never in the dark when it comes to the financial health of your business.