BUSINESS Demystifying Your Balance Sheet Your Business’s Balance Sheet We should mention that your business’s balance sheet features categories and subcategories of assets and liabilities. Assets are usually listed in an order that begins with “cash,” followed by what economists refer to as “near cash” or “cash equivalents.” In other words, those assets that can hopefully be converted into cash (short-term) quickly, or at least within a one-year period. I’m reminded of this old joke: “When you ask five economists for an opinion (or forecast), you’ll likely get at least six answers.” Current Assets You’ll recall that in our personal balance sheet example, we included such things as cash, house and car because these are things that you own. In your business, you’ll likely have such things (assets) as cash, accounts receivable (A/R) and possibly inventory. These categories are referred to as “current assets” because they are generally expected to be converted into cash (if not already cash) within the current short-term business cycle, which in accounting speak means one year. You may have noticed that although it’s not cash, accounts re- ceivable (A/R) is included in the current assets category because as customers pay our invoices, our A/R is reduced, and cash is increased. Similarly, our investment in inventory is expected to be sold at a profit, invoiced to customers, become part of our A/R and, ultimately (as our invoices get paid), converted into cash. ASSETS: Cash & Equivalents Accounts Receivable Inventory Prepaid Expenses Current Assets As we have discussed, at the end of the day, liquidity matters. Another less-understood category of current assets is called “prepaid expenses.” The best way to explain this is by exam- ple, but first we need to understand that one of the accounting principles is “the matching principle.” This means that to have reliable financial numbers, we need to “match up” or include all income, costs and expenses for the same period. As you’ll ap- preciate, leaving out any piece of this would result in a lopsided picture. In other words, reporting all of the sales for March but only 80% of the expenses would clearly be misleading. A very common example of prepaid expense would be when we pay for a life insurance policy premium (oſten in advance) for an entire year. Essentially, this means that we incurred an expense for 12 months in the future, thus the term “prepaid.” To make a long story short, the matching principle requires that we “park” this expense on the balance sheet and then basically apportion 1/12th to each month of our P&L as the fiscal (financial) year unfolds. A second common example would be where we paid a 50% deposit to exhibit at a trade show. Although this trade show is held next year, we were required to make a 50% down payment or deposit this year at the time of registration to lock in our space for next year. Again, we have paid for a service in advance and thus “prepaid” the expense. Let’s look at Figure 3 to see our current assets (and other catego- ries of assets) as they would appear on our business’s balance sheet. BALANCE SHEET | XYZ COMPANY | As of _____ month and ______ year (Probably primarily money in our business checking account) (Money customers owe us for services rendered. Becomes cash when paid) (To be sold at a profit, become A/R and when paid, then increases our cash (Future bills that we paid in advance, partial or complete) (Stuff we own/have, expected to be converted into cash within one year) Some of our inventory may not be sold, and we’ll be replacing some or all of what is sold. Some of our A/R may not be col- lected on time, or at all. But the idea is that, theoretically, these current assets are either already cash or will be converted into cash within a one-year period. Although we won’t get into it now, keep in mind that there is a sort of mirror image to current assets (you guessed it), current liabilities, where a similar timing concept applies to what we owe to others. Following are additional categories of assets that are not expected to become cash within one year. “Other” Assets “Fixed” Assets*** Total Assets Less Accumulated Depreciation (Less the amount that we have “written off” since acquisition) Net Fixed Assets (Includes such typically intangible items as patents or trademarks) (Sometimes referred to as Property, Plant & Equipment (PP&E) (Fixed Assets, less Accumulated Depreciation = Net Fixed Assets) (All Assets) Figure 3. Take a look at current assets (and other categories of assets) as they would appear on a business’s balance sheet. 24 KEYNOTES MAY 2021 WWW.ALOA.ORG
