The balance sheet is one of the main financial reports for any business. Among other things, it shows what a company owns, what they owe, and how much they and others have invested in the business. One of the characteristics of a balance sheet is how it separates what you own and what you owe into two categories based on timeframe.
Current and Long-Term
You may have seen the Assets section of your balance sheet divided into two sections: Current Assets and a list of long-term assets that might include Property, Plant, and Equipment, Intangibles, Long-Term Investments, and Other Assets.
Current Assets include all of the items the business owns that are liquid and can easily be converted to cash within a year’s time. The most common types of current assets include the balances in the checking and savings accounts, receivables due from clients that haven’t paid their invoices, and inventory for sale.
The remaining assets are long-term, or assets that cannot easily be converted to cash within a year. Property, Plant, and Equipment, also termed Fixed Assets, includes buildings, automobiles, and machinery that the business owns. You might also see an account called Accumulated Depreciation; it reflects the fact that fixed assets lose their value over time and adjusts the balance accordingly.
Intangible assets are assets that have value but no physical presence. The most common intangible assets are trademarks, patents, and Goodwill. Goodwill arises out of a company purchase. Investments that are not easily liquidated will also be listed under Long-Term Assets.
Similarly, liabilities are broken out into the two categories, current and long-term.
Current liabilities is made up of credit card balances, unpaid invoices due to vendors (also called accounts payable), and any unpaid wages and payroll taxes. If you have borrowed money from a bank or mortgage broker, the loan will show up in two places. The amount due within one year will show up in current liabilities and the amount due after one year will show up in long-term liabilities.
The most common types of long-term liabilities are notes payable that are due after one year, lease obligations, mortgages, bonds payable, and pension obligations.
Why All the Fuss Over Current vs. Long Term?
Bankers and investors want to know how liquid a company is. Comparing current assets to current liabilities is a good indicator of that. Some small businesses have loan covenants requiring that they maintain a certain current ratio or their loan will be called. The current ratio of your business is equal to current assets divided by current liabilities. Bankers like this amount to meet or exceed 1.5 : 1, although this can vary by industry.
A Key Component that is Usually Missing for Small Businesses
There is a fundamental gap with most small business bookkeeping procedures where vendor bills are not entered anywhere until they are paid. Many businesses manage their Accounts Receivable well, but have a hard time managing cash. A significant contributing factor to the issue is the void around Accounts Payable and the amount of cash in the bank that must be allocated to paying vendors. To get to a meaningful balance sheet, this key component must be included. These are your short term liabilities and are important in understanding the financial health of your business. To get to the next level of business management, implementing a more formalized Accounts Payable process may be the best next step.
Do you understand your balance sheet and do you have an Accounts Payable process? Let us know if we can help.