Very commonly, inexperienced business owners spend their time focusing on the income statement for their business. After all, what really matters is that you’re making money right? Certainly making a profit is important and spending ample time to understand your income statement is crucial to your cannabusiness success. But I recommend that you also spend some time reviewing your balance sheet. Here’s why.
A balance sheet is a picture of your business at a moment in time. Whereas an income statement tells you what has happened with the profitability of your company over a period of time (a month, several months, or years), a balance sheet reports the overall health of your company in a very different way. It shows accumulated earnings (net income) over time (like an income statement) but it also shows what you own and what you owe. The difference between what you own and what you owe is the equity your company has. A positive equity, in general, represents strong financial health. More importantly, negative equity can mean that a company is over its head and may be destined for financial trouble.
Balance sheets are divided into three sections: assets, liabilities and equity. Each of these sections is divided further into subsections but for this discussion, let’s keep it simple with just the three. The easy way to remember what these sections are is as follows:
Assets – things I own
Liabilities – things I owe
Equity – the difference between assets and liabilities
Expressed as a formula: Assets – Liabilities = Equity
Assets, things you own, are items like cash in the bank (or your vault), equipment (capitalized equipment, which will be discussed in future blogs), inventory; essentially everything that belongs to your company.
Liabilities, things you owe, are items such as accounts payable (these are unpaid bills), unpaid payroll taxes, notes payable (cash borrowed from a bank or other lender). Simply put, liabilities are amounts that you owe to others.
Equity, can be expressed as Owner’s Equity, Partners’ Equity, Members’ Equity or Shareholder Equity, depending on the type of legal entity your business is. Equity can be a hard concept to get your head around. In the simplest of terms, it is as expressed above, the difference between assets and liabilities. If your assets exceed your liabilities, you have positive equity and that’s a good thing. Another way to look at it is this. If I own more than I owe, I could potentially pay off all my debt, using my assets and still have money left over. It’s not quite that simple, but that is a good way to think about it when you’re just beginning to explore your balance sheet.
As I mentioned above, negative equity is something you really want to explore and understand. If you think about it, negative equity means that you in effect, owe more than you own. You may say to yourself, “I’m not shutting the doors now, so it’s not like I have to pay all of my debt today”. The point is that if you are sitting in a negative equity position, it means something is not working right within your company, and you need to make some plans to remedy it.
There is a direct correlation between balance sheet items and your income statement. For example, every time you have a sale, the income line on your income statement increases and the cash increases on your balance sheet. Conversely, if you pay rent, expenses increase on your income statement and the cash on your balance sheet goes down. Getting a grip on the relationship between the balance sheet and income statement will greatly enhance your ability to run your cannabusiness effectively. For most people it just takes time and study. Take the time to study and understand the important role a balance sheet plays in representing the sustainability of your business. Learn how activity on the income statement affects the balance sheet. Make certain you can reliably assure the long term viability and future of your company.