It is widespread for compact small business owners to
measure their financial health determined by their revenue statement or bank
account balance and deem their small business “fit” when the bottom
line appears very good. To reveal why this approach might be deceptive, let’s
apply a dieting metaphor.
Only looking at the bottom line is the equivalent of
“sucking it in” when you appear within the mirror. Confident, it
looks like you have lost some weight, but what takes place after you exhale?
You might appear skinny for a moment, but that version on the circumstance
In terms of your business’ overall health, the balance sheet
is definitely the “real” you. Believe in the earnings statement (also
named the profit and loss statement) as your eating plan log. It tells you how
properly you did within a specific time period—last week, last month, or last
quarter. We all know that there are excellent weeks and bad weeks on a diet
regime. If you only appear at one week or month, are you getting a true picture
of your overall health? Of course not.
The balance sheet, on the other hand, is depending on everything
you have ever done. In our diet program metaphor, it accounts for how much
you’ve exercised and what you have eaten over your entire lifetime. The sum of
all that information is what you see when you stop sucking it in.
To understand this metaphor, you need to understand what the
balance sheet is and how it relates to the earnings statement. Your revenue
statement contains information about what has occurred within the current
period. Revenue, cost of goods sold and expenses are some on the account types
found on the revenue statement.
To get an correct picture of what’s happening in your
enterprise, you must adhere to the matching principle. That means you record
expenses and cost of goods sold after you have earned the revenue that they are
related to (if an expense is not related to revenue, you record it during the
period it is used). The balance sheet accounts hold these revenue and expense
items until the period in which they are earned or used. We use accounts such
as prepaid insurance, customer deposits, and accrued payroll to classify these
things on the balance sheet.
Income statement accounts only reflect transactions in the
current accounting period. At the end on the period, the net profit or loss is
moved to the equity section of the balance sheet (to retained earnings). This
means that the balance sheet reflects all prior period revenue, cost of goods
sold, and expenses inside the form of retained earnings. The equity section
also shows how much you’ve invested in and drawn out of your business
enterprise. The equity section, therefore, shows what the company is worth to
So, how do you know if your company is “over
weight”? Take a look at your debt to equity ratio (total liabilities
divided by total equity). … Read More