What is the Purpose of a Balance Sheet?
You’re tasked with being both an attorney and a business owner. Your strength is the former, but you’re being placed in charge of creating, reading, and understanding a lot of documents in order to handle the latter.
We often get asked by attorneys what some of these documents are and why they matter. One of the most common is the balance sheet. You know you’re supposed to be taking a look at these as part of understanding your “financials.” But what is the point?
What is a Balance Sheet?
A balance sheet is the net worth of your business. It is, in many ways, not unlike the equity in a house. It’s calculated in a similar way. Just like with a house you take the home’s value minus your mortgage, with a balance sheet you take the assets of your business (cash, bank accounts, cars, whatever else) and subtract the liabilities (bank loans, car notes, other expenses) to get the book value of the firm.
Keep in mind that this is NOT the sales price. Service industries, like law firms, usually have a book value of zero because most of the business assets are excess cash and are taken out as profit in drops to the owner(s). But the balance sheet is still important.
Why Does the Balance Sheet Matter?
Balance sheets may not tell you the sales value of your business. But what it can do is help you keep an eye out on the health of your business.
Is your cash rising or falling? Why?
Is your trust account growing?
Is your debt rising or falling?
Are credit card balances rising or falling?
This can tell you a lot of different tings about your business. If your debt is rising, people may not be paying on time or you may be spending more than you can afford. If your trust account is growing, it could be a sign that you are short staffed.
Often when an owner is starving their firm of cash, this is the first place you’ll see it, since you’ll see cash dropping. Banks will also look at this number when you apply for a loan, and they’ll want to make sure that there are no signs of negative equity. If they see falling cash and rising debt, that’ll be a red flag.
How Often Should You Look at Your Balance Sheet?
Some of your financials you’ll want to look at often – at least once a week. But others, like the balance sheet, are not quite so urgent. You don’t even need to look at the balance sheet once a month. But every few months, it is a good idea to look it over, and it is especially important to pay attention to trends as these can be a sign of larger problems.
For more information about how to use your financial statements to run a more profitable firm, fill out your information on this page to get free resources for better understanding your finances.
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