The Balance Sheet is where you see what your business is really worth. After you've finished recording all your activity for the month - income AND expenses - the leftovers, profit or loss, get carried to the equity section of the balance sheet. Remember the parts of the balance sheet: Assets, Liabilities and Equity (sometimes known as capital, other times known as net worth). When you incorporate, the money left in the business is referred to as retained earnings. We can look at that more later.
As I mentioned before, assets are the things you own. Start with your bank account and go all the way through "Property, Plant & Equipment" also known as fixed assets. Fixed assets are things that have an extended useful life. Assets are broken into levels of liquidity. Cash accounts, receivables - money you are due to be paid for things you have sold - , prepaid items like February rent paid in January, or insurance premiums for the coming 3, 6 or 12 months, investments in certificates of deposit, stocks, bonds and annuities and even inventory are considered liquid assets. It's easy to squeeze the useful money out of the people holding these things. These would be people like banks, customers, brokerage houses, etc. Fixed assets are things like filing cabinets, desks, power equipment, vehicles, production machines, billboards, construction equipment, sound systems, and of course, the building and land where your business is located (assuming you own it, rather than rent or lease it from someone).
Liabilities are things you are responsible to pay to someone else. I've mentioned buying office supplies on account from a local supply store. Other examples are your credit card, the oil company you use for heat, advertisers you use, payroll deductions - for payroll taxes withheld or for employee benefits. These are short-term, or current liabilities. You can easily pay them. Long-term liabilities are your mortgage, car loan, loans from individuals or companies that you will repay over several or even many years.
Finally, we get to equities or capital. After you close your monthly or yearly books, the profit or loss gets moved into the owner's or partners' equity or else into retained earnings. If your business is a sole-proprietorship or partnership, another account is closed into the equities as well. It's called a drawing account. If you or one of your partners takes money or materials of any sort out of the business for personal use, it gets recorded in that individual's drawing account. This is a "contra" account. Here's an example: If you, at the end of May, had equity of $10,000 and you needed $3,000.00 on June 10th to cover expenses at home, you can write yourself a check from the business and put it into your personal account. This check gets recorded in your drawing account in the business. At the end of June, you'll close your books and (not counting that month's profit or loss) end up with equity of only $7,000.00. This is how sole proprietorships pay their owners. In a new or slowly growing business, this is difficult to manage. Eventually, this will smooth out as your profit grows and the business becomes more self-funding. Then you will be able to plan how much you can regularly take out of the business to pay yourself without hurting the cash flow within the business.
After all this activity is netted together - Assets minus Liabilities, the remainder is the equity: the value of the business. even though you may not have a lot of cash, you can have a lot of equity because you may have used than money to buy new or better assets or to pay off loans. In any event, this is what you want to see grow. If you do keep your business equity low, you may be taking a lot of money home and building the value of your home.
That's a lot to digest. Study this and get it clear in your mind and you will have a good foundation to help you figure out how to keep your business developing and becoming something that not only provides for you, but can also benefit others - like employees. Or, if you run it well enough on your own, you can use the profits for charitable or philanthropic purposes.
Have a good one. Keep in touch and let me know if you have questions.
Gary
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