Executive Summary: Knowing the basics of accounting is essential in business. Knowing the balance sheet will help you assess your own financial health as well as that of your clients or subcontractors. Here are some basics on the balance sheet and, specifically, the assets section.
Just the basics. I entered as a student in the business college at my university but switched over sophomore year to civil engineering. It was the three classes of accounting I took freshman year that had me wondering if I’d every become fluent in a language I call Accountingese. It was easier for me to understand that dirt plus water equaled mud than the differentiating between debits and credits.
The balance sheet is simple math:
Owner’s equity = Assets – Liabilities
And now let’s define the terms:
- Assets – things of value like cash and equipment.
- Liabilities – things you owe money on like loans or supplier invoices.
- Owner’s equity – this is also known as member equity, equity, and net worth.
The components which make up the asset and liability sections of this financial report are of interest and importance.
The balance sheet should be of interest to you too if for no other reason than the users of this document make financial decisions on your behalf based upon it. I’m talking about your banker, your surety agent, and even your clients.
Assets. Current Assets are the first thing you will see on your balance sheet. Probably the first item you will see on your balance sheet is cash. Cash is king as they say, and they’re right. Cash is listed first because it is the most liquid of your assets; assets are listed in order of strength in liquidity (cash obviously being the first in the list with prepaid expenses usually being late in the list).
If they’re not Current Assets, they are Long Term Assets. But, this is a term you will not see on your balance sheet. Current Assets are assets which can be converted to cash in a year or less, while everything else in the asset section of your balance sheet will take longer.
Liabilities and equity. Check in on a follow up writing for liabilities and equity.
My Story. I had a business and watched all of the ingredients within the balance sheet snap, crackle, and pop in good times and bad. I even sat there in an ENR Top 50 general contractor’s conference room while she picked off critical numbers from my balance sheet to assess my financial strength.
When I look at a balance sheet, the first thing I look at is cash – does (s)he have any? This is a common first question of a surety or banker. If the questioning ends there, ask for a surety bond or a line of credit immediately, because that doesn’t even tell half the story.
Cash means nothing if the Contractor owes it all to suppliers and subcontractors.
A couple things to note about the Assets side of the balance sheet:
- Prepaid Expenses – if your surety program is a function of Working Capital (the difference between Current Assets and Current Liabilities) on the balance sheet, don’t count on Prepaid Expenses being part of that surety credit. Most sureties will take that Prepaid Expenses portion of your Current Assets and discount it or remove it from their calculation. The classic example of Prepaid Expenses is that payment you make for your insurance on day one of 365 of the policy.
- Quality of Investments – the users of your financial statements (like your surety) look at the quality of your assets. As stated above, if you take your cash and keep it in Cash, that’s a surety’s favorite place for it. If you take your cash and put it in a money market account, that’s probably their second favorite spot. The 3rd favorite spot (and probably this is best stated as their most tolerable of the places they don’t want you to have cash) is in a bond account. You see, it’s all about how quickly you can liquidate assets to cash (or in the case of a surety taking you over, how quickly they can convert assets to cash). And, by the way, having cash invested in non-immediate liquid accounts counts against the value of your surety program.