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In our continuing series, we are going back to basics to help you, as a business owner, understand your financial statements and what those figures represent to you and your business.
If you missed Part 1 – which was an introduction on the Balance Sheet and what the various sections represent, you can find it here – Part 1 – The Balance Sheet.
Today’s post is going to focus on the Asset Section of the Balance sheet. As described previously, the Assets Section represents what your business owns. But not only is it important to know what it is that you own, but how liquid those assets are. And no, I don’t mean how quickly they will dissolve into water J, because that is something that we definitely don’t want to happen! (I know, I know, that was a horrible accounting joke, but I can only work with what I’ve got J)
Liquidity refers to how quickly you can convert those assets into cash if you decided to close your doors tomorrow.
So in order for this information to be readily recognizable, the Asset section of the balance sheet is generally segmented into 2 sections:
- Current Assets
- Long Term Assets
The deciding factor as to where a particular asset would reside is determined by whether it is expected to be consumed, used or sold within a certain time period. Most things in the world of accounting are dictated by your Fiscal Year, or a twelve-month period of your business, and this is no different.
Examples of what would fall into your Current Assets would be things like your bank account balance, accounts receivable, short term investments, and your inventory that will be resold.
The Current Asset Section of your balance sheet would look something like this:
Cash and Cash Equivalents
Total Cash and Cash Equivalents
Allowance for Doubtful Accounts
Total Current Assets
I’ll go through each line individually.
Cash and Cash Equivalents – this is pretty self-explanatory. You should have a separate line on your balance sheet for each bank account, as well as any different type of cash equivalent account like for Treasury Bills or marketable securities. An account would typically fall into this section if it could be converted to cash, or will mature within 3 months.
Investments – this line would cover any investments which you hold that have greater than a 3 month maturity date, but not more than 12 months. If you were holding a GIC that didn’t mature for 3 years, it wouldn’t be listed here, but in your Long Term Assets.
Accounts Receivable – this is money that is owed to you, generally by your customers, for any goods or services that you have provided to them. Again, from our liquidity definition above, you would hope to collect/convert all of these amounts in less than one year. (Hopefully you don’t have balances owing to you that are older than that….that’s another blog post altogetherJ)
Allowance for Doubtful Accounts – this line represents the amounts in the Accounts Receivable line which you aren’t sure if you are going to be able to collect. Unfortunately, one of the downsides of owning your own business, is you will occasionally have to deal with deadbeat clients or customers. (I know, that sounds harsh, but I could sit down and share some stories with you over a bottle or two of wine). The accounting world is incredibly conservative, and for that reason, if there is some doubt that you will collect some money you’ve listed in your Accounts Receivable Balance, then you would put a negative number into this line, to reduce the value of your Accounts Receivable. It doesn’t mean that you stop trying to collect it, or that you don’t pursue it with the meanest lawyer you can find, just that you are trying to represent your numbers conservatively.
Prepaid Expenses – these represent amounts that you have paid, but haven’t yet used the service. A great example of this is insurance. If you pay your insurance premiums annually, you have “prepaid” for insurance that you haven’t yet used. This amount would decrease throughout the year as the months pass. But if you were to cancel the policy tomorrow, you would likely get a refund on some of these premiums.
Inventory – Typically the last line of the current asset section, your inventory represents the goods or material that your business holds for the purpose of reselling it. Are you a shoe retailer? If you were, all of the boxes of shoes and purses that you have in your backroom and on your showroom floor, represent your inventory. (If you have too many shoes, I’m never one to turn down a pair of heelsJ)
So that’s it! Not too hard, and broken out line by line, it also makes perfect sense. These would all represent the Current Assets of your business and the first section of your Balance Sheet.
Stay Tuned for the next installment where I’ll cover the exciting phenomenon of Long Term Assets.
(I know, there was a lot of sarcasm in this post…but hopefully I was able to make you smile J)