Know your numbers. We often hear seasoned business people admonish their colleagues or mentees as such. To know your numbers is to understand what they mean, what realities they convey, and how they relate to one another. To be at home with your numbers is to connect actions or inaction triggered in response to business events to their effects on the business’s Balance Sheet. The Balance Sheet parades most of the important numbers in business.
They say accounting is the language of business, and I add, it is also its number system. As a business person, to know your numbers you must be comfortable with reading, understanding, and interpreting the Balance Sheet. We note, however, that the Balance Sheet has been renamed Statement of Financial Position by the International Financial Reporting Standard (IFRS) Foundation. But for this piece, we shall keep the Balance Sheet.
The Balance Sheet tells the position of a business at any given time. It provides insights to investors, whether providers of equity or debt, which enable them to decide whether to continue to invest in the business or to divest of it.
Here is the Balance Sheet equation: A = L + OE.
- A stands for Asset. Assets are those items that has been acquired by the business at a cost that can be easily measured. Additionally, assets must have current or future value to the business.
- L stands for Liabilities. Liabilities result from resources provided to the business by parties other than its investors.
- OE stands for Owners’ Equity. Owners’ Equity is those resources contributed to the business by its investors. In Addition, Owners’ Equity consists of the aggregate of Retained Earnings throughout doing business. Retained earnings arise from the difference between Revenue and Expense.
To note, for each of the Assets, Liabilities, and Owner Equity, referred to as Majors Accounts, there are a variety of sub-accounts under them. The piece does not intend to delve into that level of detail.
Suffice it to say that the Balance Sheet equation depicts that resources can be provided to a business by way of equity and debt. In other words, the Assets of a company can be laid claim to by her debt and equity holders, in that order. The ratio of Liabilities to Owners’ Equity indicates the proportion of stakes debt holders has in the business as compared to the equity holders. This helicopter analysis in itself could constitute an attraction to investors to keep their interest in the company or divest.
Finally, understanding and analyzing the Balance Sheet is crucial to stakeholders in a business. More meaningful analysis of the numbers in the Balance Sheet and their relatedness are carried out at the sub-account levels. For instance, Current Liabilities can be related to Current Assets to determine if a business can meet its short-term obligations.
In conclusion, know these numbers and their makeup and hopefully, you would know your business and drive it to success – Assets, Liabilities, Owners’ Equity, Revenue, and Expense. And then there is the State of Cash Flow which measures the change in cash position over time.