At the end of the month, or quarter depending on how you have it set up with your bookkeeper, you receive the three financial statements that are supposed to explain to you how your practice is doing financially, the Balance Sheet, Income Statement and Statement of Cash Flows. Now while these statements can be confusing, if explained correctly they can really help you understand where your practice stands, where it is succeeding and what areas need work.
In this three part blog series I will break down the three financial statements and how they can best be understood. We’ll start with the balance sheet.
In simplest terms, the balance sheet shows what assets your practice controls and who owns them. It’s the best report to look at when trying to determine the financial health of a business at a single point in time. The balance sheet consists of three important parts – assets, liabilities and owner’s equity. To best understand the balance sheet, one has to correctly understand what these three parts entail.
Assets are anything of value that your practice CONTROLS, regardless of who owns it. So it doesn’t matter if it’s an item that you haven’t paid off and is technically owned by the bank. If you are in control of the item it is an asset.
Some examples of assets include cash, office equipment and inventory. An interesting note to make here is that accounts receivables also counts as an asset since it represents money owed to you that hasn’t been paid yet.
Liabilities are pretty easy to understand. They are basically debts you owe to other people. Like credit card balances or payments owed to suppliers.
The simplest way to identify owner’s equity is by defining it as any asset that the practice owns 100%. So no debt on the asset, just complete ownership. Now, owner’s equity is oftentimes mistakenly used to determine how much a practice is worth in a sale. In fact, a practice value should be based on a multiple of their business earnings.
That sums up the three separate parts of the balance sheet. Now let’s look at how the three parts go together. The balance sheet follows a simple equation.
What does that mean? It means that the balance sheet shows all things of value that a practice controls, whether they own them or not (assets) and how that is equal to what they control but don’t own (liabilities) and what they control and own (owner’s equity).
That’s the best way to break down the balance sheet. By looking at the balance sheet in whole, you will get the best view of the financial health of your practice at that particular time.
Tune in next week for a simple breakdown on the Income Statement!