Balance Sheet numbers are the numbers that you will use to do the Calculations that I discuss in many of my Blog Posts.
So, I thought it would be a good idea to discuss the Balance Sheet, see where the numbers come from, and what they mean.
The numbers from the Balance Sheet that are used in the Calculations are numbers that represent the various elements of the business, such as Total Sales, Total Interest Expense, etc.
The numbers measure the parts of the business that we want to analyze.
BALANCE SHEET NUMBERS
If you don’t already have a business, then you won’t have the numbers, called Historical Data.
In that case, you will have to use estimates.
You can find useful data on the websites that track the data for the industry or business that you are in, and you use these as a guide for your own situation.
If you already have a business with historical data, or you are considering buying a business that has historical data, you will have the numbers to work with.
You will find the numbers on the Income Statement, and on the Balance Sheet of that business.
We will look at the Balance Sheet first.
And, please, you don’t need to understand everything about a Balance Sheet, you just need to know what it is, and what is inside it. And I will show you that.
BALANCE SHEET EXAMPLES
The Balance Sheet will come in all shapes and sizes, and you will eventually find the one that works best for you and your business.
You can start with the one I have below, and change it as you go along to fit your business.
WHAT A BALANCE SHEET IS USED FOR
A Balance Sheet can be done for an individual, but a Balance Sheet is normally done for a business or company, showing the company Assets, the company Liabilities, and the company Net Worth.
This “Net Worth” figure is what we use to represent the “value” of the business, and which we will use in all of our Calculations.
(”Equity” is something else, which I will get to later.)
I have a sample Balance Sheet below, with real numbers, for you to look at in a minute.
Be aware that a Balance Sheet (and Income Statement) can also be done for a specific business activity in addition to the retail sales of that business, such as a Hardware Store that also installs the fencing material that it sells, and the Balance Sheet (and Income Statement) will only reflect the condition of that specific activity of fence-installation itself.
This might be done when the activity is started, and continued for the first year, to determine if the activity itself is profitable. If it is, it might be increased. If it isn’t, it might be shut down.
And, likewise, a Balance Sheet can even be done for a single project, or for a single investment.
You can even do a Balance Sheet for your own personal finances, those that are not business-related.
Now that we know what a Balance Sheet is, it is important to understand exactly why we have one.
WHAT A BALANCE SHEET TELLS YOU
A Balance Sheet is a snapshot or freeze-frame of the specific entity or activity at a specific point in time, and covering a specific period of time up to that point.
The date chosen for the Balance Sheet is usually the end of the year, or the end of one of the quarters, and that is the time of the snapshot.
And the beginning point in time is the start of the year, or of the quarter.
Now that we know what a Balance Sheet is, and what it is used for, let’s see what one looks like.
BALANCE SHEET EXAMPLE
March 31, 2022
Accounts Receivable 3,140
Quarterly Tax Deposits 8,000
Prepaid Expenses 1,270
TOTAL CURRENT ASSETS 21,410
(Some of these items might need explanation. “Cash” is not just the dollar bills that you are holding, but also the balance in the business checking account. “Accounts Receivable” are the invoices/bills that you have created and given to the customer for the work already completed. “Quarterly Tax Deposits” are money deposited by you in accounts with the IRS or other taxing authorities to satisfy what your tax obligation will be at the end of the year, but which you are required to pay in advance every four months. “Prepaid Expenses” is money that you have already paid for products or services that you will receive in the future.)
Less: Accum. Dep. (71,280)
Book Value 288,720
Fix. & Equip. 38,000
Less: Accum. Dep. (9,441)
Book Value 28,559
TOTAL LONG-TERM ASSETS 362,279
Security Deposits 1,400
Notes Receivable 1,160
TOTAL OTHER ASSETS 2,560
TOTAL ASSETS 386,249
Accounts Payable 7,250
Credit Card 2,500
Sales Taxes Accrued 1,450
TOTAL CURRENT LIABILITIES 11,200
Notes Payable 1,750
TOTAL LONG-TERM LIABILITIES 274,294
TOTAL LIABILITIES 285,494
NET WORTH 100,755
So, that’s what a Balance Sheet looks like.
Often, an Income Statement is done at the same time to accompany the Balance Sheet.
We cover the Income Statement in another Blog Post.
Now let’s look at the Calculation involved in creating the Balance Sheet.
Now, we are getting to the point of it all, and looking at how you will use this in your business.
As you can see, all of the numbers on a Balance Sheet are related mathematically to each other, and this makes a Calculation even more useful because 1.) you can verify the accuracy of any number, and 2.) if a number is missing or unknown, you can calculate it by using the other numbers that you have.
The Calculation for a Balance Sheet is:
A = L + N, or (more helpfully)
N = A – L, where
N is Net Worth,
A is total Assets, and
L is total Liabilities
“Net Worth” in a Balance Sheet is sometimes also called “Equity” or “Owner’s Equity,” but this is not correct, and the reference should not be used.
(Let’s go off into the tall weeds for a moment, just to give you an indication of what I am talking about. There is a Calculation that is different from the Balance Sheet Calculation, and we will use it to determine the Equity that the owner has in the business.
The Calculation for Equity is:
E = FMV – MPO – L – OD, where
E is your Equity in the business,
FMV is the Fair Market Value of the business,
MPO is the total amount of your Mortgage Payoff,
L is the Liens on the business assets, and
OD is Other Debts of the business
We will discuss all of these terms elsewhere on the Blog, so that you will understand exactly what they mean and how to calculate them.)
Notice that the “value” of the business in the Equity Calculation above is described as the Fair Market Value. That is what the business would sell for on the open market today.
But notice that in the Balance Sheet, the Fair Market Value is not used. The value of the business that is used on the Balance Sheet is the Depreciated Book Value of the depreciable assets, and the true value of the other assets of the business. That number is much lower, and will not tell you what your Equity is, because those depreciated assets are probably worth much more than the number used in the Balance Sheet, making your Equity much higher.
This is why the “Equity” or “Owner’s Equity” terms that are often used in reference to a Balance Sheet should be avoided in favor of using the term “Net Worth.”
But actually, like “Equity,” the term “Net Worth” also does not accurately describe what the worth of the business is.
Net Worth is just the difference between the Book Value of the company’s depreciable assets, along with the other assets, and the total amount of your Liabilities. It’s just a number used for bookkeeping and accounting purposes. It does not tell you the total value of the company.
The actual Value of a business is a number arrived at by the Seller and the Buyer after due diligence and negotiation, and it always involves intangibles and opinions.
But there is not a way to calculate intangibles or opinions, so we calculate hard data, with the universal understanding of what it means, and that there are other individual factors which affect the actual number for each business.
You might think it best to have your accountant or bookkeeper do your Income Statement and Balance Sheet, but I disagree.
I often had clients with come to me for Tax Planning and Estate Planning, and we would discuss their tax returns, including their Income Statements and Balance Sheets, if their tax professional even provided them. If not, I would run them up myself. And during these discussions, even the best business managers were surprised to hear some of the things that I asked them about, or told them about, regarding their own businesses, and sometimes said that was not what they wanted to be doing.
Of course, it is important to focus on the product or service that you are providing to your customers. It all begins there.
But if you learn one other thing, I strongly suggest that you learn Bookkeeping, and then gradually learn some Accounting.
It is a way to increase your income by, in my opinion, 20-30%, just by increasing your knowledge, everything else staying the same.
I touch on this same concept in more than one of my books, but the one with the most detailed information is “Do This, Not That!” and you can find it here on this website. Use the 3D Flip Reader to look at the Contents and read the first few chapters.
The paperback is available on my Amazon Author Page, along with my other books.
And I have related Articles about real estate investing and other real estate matters from other perspectives on my LinkedIn Page.
I am also active on Quora.com where I have answered over 300 questions, and they have almost 3 Million views.
If you happen to be doing, or if you are considering doing, a Section 1031 Like Kind Exchange, then you will really appreciate the value of what we are talking about, and I have a lot of material for you to consider on my S1031 Exchange website.
You should always check out the credentials of anyone, like myself, who you are relying on for accurate information by looking closely at their Biography. Here’s mine.
If you are interested in exploring my Catalog of Real Estate Investing books, but don’t know where to start, I suggest these three.
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