How to Read Financial Statements Part 3: The Balance Sheet

Cheryl Miki returns to close out her 3 part series exploring financial statements. You may access part 1 and 2 below.

How to Read Financial Statements Part 1: Basic Profit and Loss

How to Read Financial Statements Part 2: Complex Profit and Loss

How to Read Financial Statements (Part 3 – Balance Sheet)

Oh balance sheet, you poor misunderstood creature. How often are you ignored?

So often! And so sad because the balance sheet is absolutely crucial when trying to answer that most common question: Are we ok?

Too often we turn to the Profit and Loss statement to answer all our financial questions, but the P&L cannot tell us how much money we have. The P&L can only tell us what we’ve done in the past (earned money, accumulated expenses in order to earn that money); it cannot tell us if we have any money in the bank or whether can afford to do the things we want to do in the future.

So let’s all make friends with the Balance Sheet, the most clairvoyant of reports.

The Balance Sheet is divided into three sections:

Assets: What you own

Liabilities: What you owe

Equity/Net Assets: What you are worth

Assets are things that the company owns, like money and things that could be converted into money if need be. Some of the typical assets non-profit organizations have are:

  • Bank Accounts: money in the bank as of the balance sheet date, minus any cheques you wrote that haven’t been cashed yet.
  • Accounts Receivable: money that people owe you, but haven’t paid yet.
  • Grants Receivable: grants that you have been awarded, but have not yet received.
  • Prepaid Expenses: Things you’ve paid for in advance, like a rental deposit. It is an asset because you could conceivably get that money back if you had to.
  • Capital Assets: physical things you own like buildings, land, and equipment. Again they could be sold and turned into money.

Liabilities are things you owe or would have to pay back if the company folded. Typical liabilities for non-profits are:

  • Accounts Payable: These are the bills that you haven’t paid yet.
  • Accrued Liabilities: This is a fancy term for a bill that you know is going to come in but you haven’t received yet.
  • Deferred/Unearned Revenue: This is money that has shown up in advance of when you’re supposed to use it. Grant money is often like this, same with ticket sales in advance of an event. It shows up as a liability because if the future event didn’t happen, you’d have to give the money back.
  • Credit Card Debt: If you have a company credit card, all the transactions that you haven’t paid off are liabilities.
  • Bank Loans

Equity/Net Assets is what your organization is worth. It is literally the difference between what you own and what you owe, meaning if you add up all your assets and subtract the liabilities, what’s left is what you are worth.

Your equity goes up and down based on what you earn (or lose) over the course of the year as shown on the Profit & Loss statement. Equity is crazy important to all those “for-profit” companies. They are always trying to grow their equity to show how profitable they are and to pay dividends to shareholders. But non-profit organizations are not so interested in growing their equity because they are, by definition, not trying to accumulate profits. They are trying to break even.

Take a look at the example below.

This organization owns $44,00 in assets, but they owe $36,000 in liabilities. So the organization is worth $8,000. (Note I’m only talking about financial worth, which doesn’t take into account the non-financial value of the work the organization is doing, like say making the world a better place to live in. That’s a whole other discussion.)

So what does all this tell me?

Well, if you look at your cash assets (money in the bank and the receivables that will come in shortly) you can see how much cash is available in the bank, plus how much will be coming in soon from receivables. It also helps you gauge whether you’ll have enough to pay for your programming.

It also tells you about your debt. The payables and short term loans have to be paid for in the near future. Do you have enough assets to pay for them?

And the balance of your equity/net Assets tells you your overall health. Are you close to the break-even point? Have you built up losses over the years that need to be addressed? Do you have a bit of breathing room because you’ve had a couple of good years in a row? Are you going to be ok?