The purpose of the balance sheet is to give, at a point in time, a picture of the financial position of a company. It has three components: assets, liabilities, and equity.
Sounds simple enough, right? Not so fast. Sometimes it can be difficult to determine if a warrant is equity or a liability for GAAP purposes (e.g., if convertible debt is part liability and part equity, if preferred stock is actually a liability, etc.). Confused? Why should a startup or early stage entrepreneur care? A future post will discuss this more.
The balance sheet can provide insight into the health of the company. For example, a current ratio, which is calculated as current assets divided by current liabilities, greater than one (1) indicates that the company has the ability to pay its obligations on time. Additionally, by dividing current liabilities by equity, one can assess the extent to which the company is leveraged. A higher leverage ratio may indicate the company will struggle to repay debt with the current level of stockholder investment.
For more information on how you can use your financial statements to more effectively manage your business, please contact your Aronson advisor or Danielle Meyer at 301.231.6200.
About the Author: Danielle Meyer is a manager in Aronson LLC’s Technology Industry Services Group, where she provides comprehensive audit and accounting services to a diverse group of companies operating in the high tech, biotechnology/life sciences, e-commerce and software sectors.