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What is a balance sheet and how do I read a balance sheet? Numarics provides answers.

25 January 2022

Contribution by Volker Doberanzke, PhD, Numarics Chairman of the Board of Directors and Professor of Finance and International Management

Once you have started your business, you will have to perform a variety of administrative tasks. Some of them are required by law. These include the annual preparation of a balance sheet and an income statement. Numarics keeps both documents ready for you as part of the accounting. The balance sheet provides you with important key figures on the source and application of funds. Learning to read them gives you valuable indicators about your business. What exactly a balance sheet is, how it is structured and what you can take from it, is explained in this article. 

 

The balance: where do the funds come from and where do they go?

The balance sheet is one of the most important documents for your company. And it helps you to keep an overview at all times. But how is the balance sheet structured and what does it contain?

Basically, the balance sheet has two sides. The asset side (left side of the balance sheet) and the liability side (right side of the balance sheet).

The active...

The active side of your balance sheet shows the assets. That is, all the assets you use for your business. First of all, this includes all the items you need to run your business, such as your business vehicle, your office equipment, your computer and printer, etc. The active side also includes all "non-material" assets such as bank balances or investments that you have made, for example, in order to profitably invest funds that you do not currently need. The asset side thus shows what you have done with the money available to you - whether you have invested your own money or, for example, taken out a loan to buy a business vehicle. That is why the active side is also called the "use of funds" side.

To ensure that your investments are well structured, the asset side is divided into two parts. The current assets and the fixed assets.

Current assets are the part of your assets that can be converted into cash in the short term (i.e. within one year). Current assets are generally classified according to liquidity and include, among other things, cash and cash equivalents, bank balances, your receivables from business partners (debtors) and your inventories. 

Under current assets are fixed assets. This includes all assets that are available to your company for a longer period of time (usually several years), e.g. the office equipment, business property, machines, etc. mentioned above.

...and the passives

The liabilities side (right side of the balance sheet) tells you where you got the money that you used for the assets side. The liabilities side is therefore also called the "source of funds side". Similar to the assets side, the liabilities side is also structured according to maturities. It starts with the short-term borrowed capital, for example your overdraft at your bank or outstanding invoices that you still have to pay (creditors).

This is followed by long-term borrowed capital. These are, for example, long-term mortgage loans that you have obtained from your bank.

Below the long-term borrowed capital are the funds that you yourself have contributed to the company: Equity capital. Your profit is also shown here.

We have now looked at all the components of a balance sheet. Schematically, the balance sheet looks as follows:

In principle, a balance sheet is always balanced, i. the sum of the assets and the sum of the liabilities always have the same balance. But how do you achieve equality between the two sides? If everything is correctly accounted for, the balance basically takes place via the equity / profit account. And another thing is important: The balance sheet is always only a snapshot and changes daily. An important balance sheet date is often December 31, which is normally the day a fiscal year ends.

Are you growing with your business activities? Then your balance sheet grows, too: Let's assume you buy a new company car and finance the purchase price with a loan. Then both the assets (business vehicle) and the liabilities (long-term loan) increase.

With Numarics as your business operating system, you always have your balance sheet at hand. We book all receipts for you and create your balance sheet in real time, so you always have a clear overview. And enough time for what is really important for you: your clients.

Volker Doberanzke, PHD
Numarics Chairman of the Board of Directors and Professor of Finance and International Management
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