The key to understanding your balance sheet and financial terms is understanding the terms used on the balance sheet and by your accountant to describe your financial situation. The following are definitions of many of those terms.
Current asset: A current asset is an asset that will be used in a business year or cycle, such as cash and inventory.
Current Liability: A current liability is a liability that will mature and is expected to be settled in cash within a year or business cycle, such as accounts payable or credit lines used.
Fixed asset: A fixed liability or a long-term asset is a liability that cannot be quickly converted into cash, it is not sold to the public, but is used by the company in operations such as automobiles, buildings, machinery or equipment.
Fixed liability: A fixed liability is a debt that will not be paid off within a year, such as a mortgage,
Current ratio: The current ratio is current assets / current liabilities. It is an indicator of the liquidity of a corporation and reflects its ability to pay its bills. In general, banks and investors look for a current ratio of 2, but this can vary by industry. Companies with inventories that roll over faster than payable may survive with a lower ratio.
Working capital: Working capital is Current Assets – Current Liabilities.
Cash Flow – Cash flow is cash in minus cash out over a fixed period.
Return on Investment or Rate of Return: Increase in value / initial investment. In most small businesses, calculating this from the balance sheet will not tell the whole story. Small business owners will likely get benefits from the business that reduce the present value, but are the result of the business operation, such as paychecks, bonuses, auto, life insurance, rental of personal assets rented from the business and others. It’s good to calculate this number so you know that your money is working efficiently. There is no point in running your business and risking your investment to get a 1% return.
Debt: A debt is an increase in an asset or a decrease in a liability. A credit is the opposite of a decrease in an asset or an increase in a liability. Your many accountants have a long textbook definition, but in almost all cases it is that easy.
Copyright 2010 Original Content Thomas Robinson