Understanding financial statements is essential to the success of a small business. Financial statements can be used as a road map on your business journey to economic success. Using numbers as navigation aids can steer you in the right direction and help you avoid costly "breakdowns." Most business owners don't realize that financial statements have a value that goes far beyond their use to prepare tax returns or loan applications.
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The balance sheet is a snapshot of the company's financial position at an instant in time. It shows what the company owns (assets) and what it owes (liabilities and net worth). The "bottom line" of a balance sheet must always balance (assets = liabilities + net worth) The individual elements of a balance sheet change from day to day and reflect the activities of the company. Analyzing how the balance sheet changes over time will reveal important information about the company's business trends. You can monitor your ability to collect revenues, how well you manage your inventory, and even assess your ability to satisfy creditors and stockholders.
Liabilities and net worth on the balance sheet represent the company's sources of funds. Liabilities and net worth are composed of creditors and investors who have provided cash or its equivalent to the company. As a source of funds, they enable the company to continue in business or expand operations. If creditors and investors are unhappy and distrustful, the company's chances of survival are limited. Assets, on the other hand, represent the company's use of funds. The company uses cash or other funds provided by the creditor/investor to acquire assets. Assets include all the things of value that are owned or due to the business.
Liabilities represent a company's obligations to creditors while net worth represents the owner's investment in the company. In reality, both creditors and owners are "investors" in the company with the only difference being the degree of nervousness and the time frame in which they expect repayment.
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