Did you know you have a balance sheet? If you are a small business owner, then you do have a balance sheet. What is a balance sheet? Most dentists don’t pay much attention to their balance sheet so I thought I would explain what it is and what it communicates. We will start at the top with assets.
Assets are things that can be used to generate revenue through the sale of goods and services. Assets include cash, inventory, furniture and equipment, and accounts receivable. A business may also own intangible assets such as goodwill.
Generally Accepted Accounting Principles (GAAP) assumes that all assets of a business are either owned outright by the business owners or are subject to the claims of creditors. Creditors include anyone who has loaned money or extended credit to the business. Loans and other forms of extended credit are called liabilities. The portion of assets not subject to claims by creditors is called equity.
In the GAAP framework there must a balance between assets on the one side and the total of liabilities and equity on the other side. This is represented by the fundamental equation of accounting:
Assets = Liabilities + Equity
This equation is also the basis for the most basic of accounting reports, the Balance Sheet. A balance sheet reports what a business owns (assets), what it owes (liabilities) and what remains for the owners (equity) as of a certain date. This equation must always be in balance.
Equity as Residual Claims
Equity is simply the difference between assets and liabilities. The owner has positive equity only to the extent that assets exceed liabilities. If a business has $2,000 of assets and $600 of liabilities the $600 of liabilities are, in effect, a claim on the assets. Equity is the difference between the assets and liabilities, or $1,400.
Equity = Assets – Liabilities
Equity is simply the difference between assets and liabilities. The owner has positive equity only to the extent that assets exceed liabilities. If a business has $1,000 of assets and $500 of liabilities the $500 of liabilities are, in effect, a claim on the assets. Equity is the difference between the assets and liabilities, or $500.
Keep in mind that a balance sheet is a snapshot of your assets, liabilities and equity at a particular point in time. At any point in time you can see the amount of cash, fixed assets and how much you owe (liabilities). If you have any other questions about your balance sheet, contact your manager.