Have you ever looked at an official financial statement from the company you work for? Did it make sense to you? If the answer is no or you can’t remember, keep reading. Continuing on with our FM’s Guide to Accounting series, this week will cover The Balance Sheet.
I have taken multiple classes in finance, but I am still not an accountant and neither are you. These things can get confusing for a few reasons. First, there is no standardized mold that all organizations use for all of their accounts. This means you’re going to see financial jargon that you won’t necessarily recognize because it won’t fit into a model of the “normal” company’s financial statement you might have seen previously. Second is the fact that you must have context to understand financial statements. Management decisions, the economy, changes in technology, etc., all affect what you see on financial statements. Third, people create these documents and those people are fallible. This is not an exact science. My goal here is for FMs to have a basic, but solid, understanding of what financial statements are, what information you can obtain from them, and why that might be useful to you.
Financial statements can be found in the organization’s annual report. There are three main types that you should be familiar with as a facility manager: the income statement, the balance sheet, and the statement of cash flows. Last time we covered the income statement and today we will cover the balance sheet.
The Balance Sheet
Referred to as a statement of financial position (SOFP) in not-for-profits, the balance sheet is a snapshot of a company’s financial position at one moment in time. The balance sheet includes assets, liabilities, and equity, which again balances this equation:
Assets = Liabilities + Owner’s Equity
Generally, the assets are listed first in one section and the liabilities and equity follow in a second section, like the two sides of the equation. Assets are listed in order of liquidity (how quickly they can be turned into cash). Liabilities are listed in order of when they will be paid off. Equity is the difference between the assets and the liabilities. It is the net worth of the organization.
Think about it in terms of your home or car. The asset is the home. The liability is the mortgage. And the difference in the two is your equity in the home. If you didn’t own or owe anything else, that would be your net worth. Take a look at this figure, which shows an example of a generic balance sheet:
Notice that in each year, the total of liabilities plus equity equals the total of all assets. Thus, the equation balances. The date in the heading of the balance sheet tells you when the snapshot was taken. Similar to the income statement, additional columns can be added for variances between the time periods to aid in trend analysis.
The balance sheet can give management, employees and investors a lot of information about the financial health of the organization. It is a direct reflection on how efficient the organization is at managing its liabilities and using its assets. You can determine how much of the assets come from creditors (these are liabilities on the balance sheet) and from owners (equity). An organization should use leverage wisely. Leverage is using debt (borrowed money) to acquire assets. Companies that use a lot of debt compared to equity are “highly leveraged.” Using leverage can be smart because the organization frees up cash in order to grow the business at the same time. However, too much debt can indicate financial problems.
The balance sheet is an important document because you can understand not only exactly what the financial position of the organization is, but also how they operate and leverage debt. Understanding this gives you an insight into where the organization will go in the future, how aggressive they will be, and if they are in financial trouble. Join me in the next part of our Intro to Accounting Series as we explore balance sheets.