Understanding how your business functions financially is often one of the most overlooked yet important functions of being in business. Beyond the necessity of cash flow and understanding where your money is going each month, is the critical matter of being able to adequately represent your business’ financial viability for creditors, vendors, bankers and even potential investors. Unfortunately, in some cases small business owners don’t realize how important it is to have current and accurate financials until they are ready to buy a house or need to get a loan to invest in their business. Years often pass where the owner’s personal equity is grossly under-reported making securing loans difficult if not impossible especially in today’s tighter lending market.
Owner’s Equity
To establish what the business and in many cases, what the business owner(s) are worth there are a few basic steps in making the calculation. First, gather information on all personal assets including the home, jewelry, cars, vacation property, retirement, savings and any other personal belongings. Next total all liabilities the individual has including outstanding debts such as a mortgage, credit card debt, student loans, or any other financial obligations. Now take all assets and deduct liabilities. This number will be the individual’s total net worth.
The same calculations hold true when looking for a business’ net worth. Using the balance sheet, liabilities are subtracted from assets resulting in a net worth figure. For corporations, the calculation will need to include shareholders/stockholders on the equity portion of the balance sheet. Included in the stockholder section would also be line items for reserves, retained earnings, stockholder equity, and capital. However, we need to take into consideration the fact that your accounting books is not a valuation of your business.
Two other reports which are critical to understanding the business’ financial health include the income statement, which reports the company’s profit and/or loss and the statement of cash flow, which provides a reporting of the business’ ability to generate cash.