Business Basics: What Is a Balance Sheet?

business balance sheet

In short, a balance sheet is a simple report that shows your assets (what you own) and business liabilities (what you owe) in a specific moment in time. It is a vital document, just like a profit and loss statement.

All business owners should learn how to read their balance sheet in order to understand their business’s financial health.

Let’s break a typical business balance sheet down and look at each section. Short and long term assets and liabilities.

Many business owners don’t realise that buyers expect there to be a “normal” amount of working capital in the business when they buy it. Working capital deals with current assets and liabilities and is generally defined as cash + accounts receivable + inventory – accounts payable and accrued liabilities.

In most successful businesses, this is very much a positive number. At the very least the ratio of current assets to current liabilities should be 2 to 1. Anybody who has tried to run a business with lower or negative working capital knows how important this item is.

Having adequate working capital in the business at the time of sale is particularly true of “share” deals where the buyer is usually buying  everything on the balance sheet. The last thing a buyer wants to have to do is pay for a business and then, on the first day he owns it, inject another sum of money into the business for working capital to keep it afloat. If there is inadequate working capital in the business at the time of sale, the  purchase price will often be reduced.

If a buyer is doing an asset deal, the buyer can, to some degree, pick and chose what assets and  liabilities they want to buy. Generally the buyer will buy the customer accounts, the good will attached to the business (including the telephone number and company name) and maybe the inventory and a couple of vans.

So here, working capital does not come into play so much. But in an asset deal where the buyer is  keeping the target business in place and operating it as a separate business, they will want working capital in the business when they buy. It is wrong to think that requiring working capital only goes with share deals.

Normal working capital required to run a business can vary enormously, depending on industry and service.

Let’s move to the longer term or fixed assets and liabilities on your balance sheet. Most deal practitioners assume that when you value a business using a multiple of earnings, the fixed assets used to produce those earnings are included in the purchase price they offer.

This seems inherently sensible to me. So the bottom line here for security dealers whose major fixed asset other than buildings are vans, you are not likely to get extra money for your vans when you sell.

What I have laid out here are general guidelines as to what to expect in terms of value from your balance sheet at the time of sale. There are exceptions to these guidelines, but generally, if you are dealing with an informed buyer, there will be less extra value on your balance sheet than you first might think.