The Balance Sheet is always in balance.(Refer to Balance Sheet Page and Sample Balance Sheet to familiarize yourself with terms and look of Balance Sheet)
The Balance Sheet is comprised of:
1. Assets (things we own); Current and Long-term
2. Liabilities (things we owe); Current and Long-term plus Equity (shares owned by shareholders/owners)
The reason Equity is a Liability is that the company owes money to the shareholders if and when they decided to sell their shares in the company. For most coffee businesses, there are likely between 1-5 shareholders who have each contributed funds in exchange for a percentage ownership. The percentage ownership is reflected in number of shares owned by each individual. For example, in our Sample Balance Sheet Page, there exists 100 common (voting) shares. If a partner owns 20% of the company, they own 20 common shares. (I will post more on Common and Preferred Shares soon)
The most important thing to know is the following equation:
ASSETS = LIABILITIES + EQUITY
ASSETS are for our purposes:
Short Term; cash on hand, bank accounts, investments and receivables
Long-term; equipment (tables, chairs, coffee makers and espresso machines) and leasehold improvements (things you've done to the space you rent, but cannot remove when you leave, ie cabinetry, flooring, washrooms)
When we add these things together we know, because we are working on a Balance Sheet, that the Liabilities plus Equity will equal this figure.
LIABILITIES are:
Short Term; accounts payable under 1 year(suppliers, rent, utilities, taxes payable)
Long-term; bank loans (note: there is usually a note listed in the Financial Statements outlining the terms of any outstanding loans, and lease agreements)
Example: In this simple example, our Balance Sheet is truncated, but clean and clear. We have $2,000 in cash, 20k in the bank, 50k in equipment and 72k in total assets. On the other side of the Balance Sheet, we owe 5k to suppliers, are making payments on a 20k bank loan, and as an owner we have 47k in value built up in the company.
ASSETS
cash 2,000
bank account 20,000
equipment 50,000
total 72,000
LIABILITIES
accts payable 5,000
bank loan 20,000
equity 47,000
total 72,000
If we decide to upgrade some equipment and take a bank loan for $20,000 out to do this, our new Balance Sheet will look like this.
ASSETS
cash 2,000
bank account 20,000
equipment 70,000
total 92,000
LIABILITIES
accts payable 5,000
bank loan 40,000
equity 47,000
total 92,000
Our Balance Sheet has grown, but the shareholders didn't profit, in fact cash flow will now need to be diverted to service the new debt, thereby reducing the profit at the end of the year. There are many different ways we could have acquired the equipment without taking on a new loan, lease, lease to own, pay cash, or issue preferred shares. Each has a cost associated with them, some more costly than others.
A very important factor I have omitted is the fact that new equipment depreciates the moment we take possession. (think new cars) This depreciation always happens at a constant rate determined by Generally Accepted Accounting Principles, normally 10-20% per year. This means that we need to reduce our ASSET equipment account by 20% of 70k each year, and if we do that, we need to reduce our LIABILITIES account by the same amount because we are working on a Balance Sheet. If we are reducing the value of equipment by 20% per year, and we are not paying off the equipment by more than 20% per year, we need to reduce the equity account by the difference to keep the sheet balanced. This means less value for the owners.
Play around with these concepts, apply them to your own situation and let me know if you find this helpful.
Showing posts with label Balance Sheet. Show all posts
Showing posts with label Balance Sheet. Show all posts
Thursday, 15 December 2011
Balance Sheet is a representation of a company
Balance Sheet
The Balance Sheet is a representation of a company's Assets and Liabilities and Shareholder Equity at a specific moment in time, for example, Balance Sheet as of June 30. A Balance Sheet is always balanced, Assets on one side, Liabilities and Shareholder Equity on the other. If for example a company has 200 000 in assets, and owes 100 000 to suppliers etc, Shareholder Equity must equal 100 000. 200 000 = 100 000 + 100 000
Assets are all about listing what the company owns including cash, inventory, receivables, pre-paid expenses, short and long term investments, property, facilities and equipment. On a Balance Sheet, the Assets are listed in order of how quickly they can be exchanged for cash. For a coffee company, this means your cash in the bank, investment accounts, money customers owe you on account, inventory of cups, coffee, tea, office products, espresso machine, coffee makers, cash registers and any owned buildings and property. For a coffee company, conserving cash which can be used to make timely acquisitions and reducing debt is the key to long term success.
Liabilities and Shareholder Equity are the opposite side of the Balance Sheet. Liabilities are grouped into two different types, short term and long term. Short term liabilities are things which need to be paid within a year such as any unpaid supplier invoices, phone bills, utilities and taxes. Long term liabilities are usually bank loans, bonds, unpaid rent and lines of credit. An important note about Liabilities, because Assets = Liabilities + Shareholder Equity, increases in debt necessarily reduces Shareholder Equity. Conversely, if a company has very little debt, the owners wealth increases one dollar for every dollar that debt is reduced.
Current Ratio is a tool sometimes used by financial institutions to determine a company's ability to meet it's short term payables. The Current Ratio is expressed as the relationship of Short Term Assets to Short Term Liabilities. A ratio of 1 or better is considered good. A ratio of below 1 would indicate that the company may have a difficult time in meeting it's short term obligations. While not a black and white measure of a company, it is a helpful tool in understanding what your banker thinks of your coffee company.
The Balance Sheet is a representation of a company's Assets and Liabilities and Shareholder Equity at a specific moment in time, for example, Balance Sheet as of June 30. A Balance Sheet is always balanced, Assets on one side, Liabilities and Shareholder Equity on the other. If for example a company has 200 000 in assets, and owes 100 000 to suppliers etc, Shareholder Equity must equal 100 000. 200 000 = 100 000 + 100 000
Assets are all about listing what the company owns including cash, inventory, receivables, pre-paid expenses, short and long term investments, property, facilities and equipment. On a Balance Sheet, the Assets are listed in order of how quickly they can be exchanged for cash. For a coffee company, this means your cash in the bank, investment accounts, money customers owe you on account, inventory of cups, coffee, tea, office products, espresso machine, coffee makers, cash registers and any owned buildings and property. For a coffee company, conserving cash which can be used to make timely acquisitions and reducing debt is the key to long term success.
Liabilities and Shareholder Equity are the opposite side of the Balance Sheet. Liabilities are grouped into two different types, short term and long term. Short term liabilities are things which need to be paid within a year such as any unpaid supplier invoices, phone bills, utilities and taxes. Long term liabilities are usually bank loans, bonds, unpaid rent and lines of credit. An important note about Liabilities, because Assets = Liabilities + Shareholder Equity, increases in debt necessarily reduces Shareholder Equity. Conversely, if a company has very little debt, the owners wealth increases one dollar for every dollar that debt is reduced.
Current Ratio is a tool sometimes used by financial institutions to determine a company's ability to meet it's short term payables. The Current Ratio is expressed as the relationship of Short Term Assets to Short Term Liabilities. A ratio of 1 or better is considered good. A ratio of below 1 would indicate that the company may have a difficult time in meeting it's short term obligations. While not a black and white measure of a company, it is a helpful tool in understanding what your banker thinks of your coffee company.
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