The world of small business bookkeeping and accounting can get a little confusing and overwhelming. When crediting an asset actually decreases its value, but to decrease the value of a liability you have to apply a debit, it’s easy to get lost and make mistakes that could affect the important financial decisions that you make in your business. While we’re not trying to write a textbook on bookkeeping terminology, we thought we’d break down some bookkeeping terms for beginners , starting with what you might find on your balance sheet.
What is a Balance Sheet?
A balance sheet is a list of all the assets, liabilities and shareholder equity in a business. As the name indicates, a balance sheet has to balance at all times, so the assets of a business must always equal the sum of the liabilities and the shareholder equity:
ASSETS = LIABILITIES + SHAREHOLDER EQUITY
Expressed a little differently:
SHAREHOLDER EQUITY = ASSETS – LIABILITIES
What this rearrangement of the fundamental balance sheet equation tells us is that the business owner (the shareholder) owns whatever is left over when you take all the assets of the business and take away all of what the business owes to others.
The goal of the business owner is to operate the business at a profit each year so that the value of the assets increases faster than the liabilities, thereby increasing the shareholder equity.
Your balance sheet gives you a snapshot of the value of all of the assets, liabilities and shareholder equity at a particular moment in time.
Let’s dig a little deeper and understand what assets, liabilities and shareholder equity are.
What is an Asset?
Simply put, an asset is something of value that your business owns.
An asset can be something you can touch, but it can also be something that doesn’t physically exist. For example, office equipment, production equipment, inventory on hand and company vehicles are all examples of physical or tangible assets – assets you can touch.
Intangible assets are things that your business owns that you can’t physically touch. Things like accounts receivables (monies owed to the company by your customers and clients), patents and intellectual properties are examples of intangible assets.
Assets can also be broken down into liquid assets and fixed assets based on how easy they are to convert to cash. A bank account is the most liquid type of asset because it is already cash. Accounts receivables are considered liquid assets because it’s assumed that your customers are going to pay the invoices you send them relatively soon. A building is an example of a fixed asset because it isn’t so easily converted into cash.
What is a Liability?
A liability is the direct opposite of the asset – it’s something that the business owes. There are no such things as tangible or intangible liabilities, because you can’t physically touch something you owe.
There are short-term and long-term liabilities, though, which relates to how soon you’re expected to pay them off. Short-term liabilities include accounts payable because your customers expect you to pay them relatively quickly, but a mortgage on a commercial building might be repaid over several years so would classify as a long-term liability.
What is Shareholder Equity?
As the name implies, shareholder equity is how much of the company’s collective value (the sum of its assets) the shareholders own. Shareholder equity is also commonly called owner’s equity.
Shareholder equity can be distributed among many people by way of the purchase of shares in the company. Owning shares in a business can be quite complex because there are different types of shares, but in most small to mid-sized businesses a single person or only a few people are the shareholders. When the business is sold the sale price is typically distributed among the shareholders based on the number of shares that they own, and paying dividends to the shareholders can be a tax efficient method of paying owners who work in the business.
Do You Need a Bookkeeper?
Understanding what a balance sheet, assets, liabilities and shareholder equity are just a drop in the ocean of small business bookkeeping and accounting. Managing your business books can be very time consuming, overwhelming and if you’re not in full compliance with CRA’s many rules and regulations then you could be subject to interest payment, fines and penalties. If you’re having trouble keeping up with your business finances, maybe it’s worthwhile talking to a professional bookkeeper about how they can help your business.
The Bottom Line
Assets, liabilities and shareholder equity are the foundation of the value of your business, and the balance sheet arranges them neatly in an easy-to-understand snapshot. The aim of most businesses is to run profitably so that the value of your assets increases faster than the value of your businesses liabilities so that shareholder equity grows. When you sell your business, the value of the shareholder equity is a significant factor in determining the price a buyer is willing to pay.
Simply Bookkeeping1 provides professional bookkeeping services for freelancers, solopreneurs and owners of unincorporated and incorporated businesses. We customize our services based on your needs – we only see some of our clients a few hours a month but others we see on a more regular basis. Our services are reasonably priced and we tightly track the amount of time we spend working for you so you only pay for the services you get.
To learn more about us, please visit our website at www.simplybookkeeping1.com or contact Michele Hyde by phone at (647) 668 – 9363 or by email at email@example.com.
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