Do you understand what your accounts are telling you, or is it something that you leave to your accountant?
When it comes to wanting to borrow money, a lender will put a lot of emphasis on the financial strength of your business and, for this, it will look to your accounts. In this short series, we will explain the main sections of your balance sheet and profit and loss account, and what they tell a lender about your business.
Your balance sheet is a summary of all the assets, liabilities and equity invested in your business. It is called a balance sheet because it balances!
The section at the top of your balance sheet records the financial value of the physical assets in your business. This will typically include property, plant and machinery, and technology, such as laptops and PCs. The value will reflect the price you paid for the asset less an allowance for wear and tear over time, known as depreciation.
A lender might see an opportunity for security in the fixed assets, particularly if they include property.
The next section of your balance sheet covers the assets that constantly move in and out of your business as a result of your trading. For this reason, they are sometimes referred to as 'floating assets'. Because the value is constantly changing, your balance sheet will capture the value at the moment in time the accounts are struck.
Items that you will see in your currents assets include stock, debtors (i.e. the money that you are owed on outstanding invoices) and any cash in the bank.
Specialist lending products exist to allow you to borrow against stock and trade debtors, and a lender, or your broker, might suggest exploring these if you need money to support your current trading.
Your current liabilities sit underneath your current assets and represent the money that your business owes because of its trading. As with your current assets, the value will be constantly moving.
The most common current liabilites are: trade creditors (i.e. the money that you owe for goods and services that you have yet to pay for), bank overdrafts, short-term loans and hire-purchase agreements (i.e. loans that are due to be repaid inside five years), and tax (e.g. VAT, PAYE and NI).
A lender will look here to see what other commitments you have outstanding.
The total of the Current Liabilities will be deducted from the total Current Assets to provide a Net Current Assets figure.
This is an indication of your business's liquidity and its ability to meet its commitments on time. A positive net current assets position is generally taken as a good sign, and a negative figure, a warning that the business might not be generating the cash that it needs to support the current level of turnover. There are huge generalisations in this statement and many credible reasons can exist as to why your accounts might not comply with these norms. We'll cover these later in this series.
Long term liabilities are liabilities that are due to be settled in more than five years. An example might be a mortgage or other long-term loan.
Your total fixed assets plus your net current assets minus your long term liabilities gives you your net asset position. This is the sum of the assets in your business. Put another way, if you were to cease trading today and collect all the money that was owed to you, pay all your suppliers and other creditors, and sell all the stock and fixed assets at their book value, this is what you would be left with.
A lender will be looking for a positive figure here. If it is negative, the business is technically insolvent.
The Net Assets are represented by the equity in the business and this section of the balance sheet shows how the equity is made up.
This is the money that you and any other shareholders put in to start the business or have put in since. Sometimes, it is just a notional sum, perhaps £100, other times it can be more. In return for these funds, you will have been issued shares in the business.
Sometimes called "retained earnings", this is the accumulation of all the profits and losses that the business has made, after payment of any dividends, up until the date of the last accounts.
The current year earnings are the profit or loss the business has made in the trading year to date and is an indication of whether the business is presently profitable.
The total of shareholders funds plus retained earnings plus current year earnings gives the total equity, or net worth, of the business. This figure will balance with the Net Assets figure shown in the section above and, as we have seen, most lenders will look for a positive figure here.
So, there you have it, a basic guide to one of your main financial statements - your balance sheet. Later on in this series we will cover some of the nuances in interpreting it along with some of the less common items that might appear. Next up, though, will be your Profit and Loss Account.
Image credit: Philippe Put, www.ineedair.org, creative commons