Balance Sheet Basics: Long-term Assets and Liabilities

I shared the basics of short-term assets and liabilities and how you can use that information to make sound business decisions in my previous posts. long term assetsLong-term assets and liabilities are just as important and extend past the current year.

Sometimes it’s helpful to assess long-term assets against long-term liabilities to gain a picture of the money coming in to your business and leaving it in the future. To do this, you’ll need to understand what long-term assets you have and compare them to long-term liabilities.

Long-term assets

This asset type is used for things not quickly converted into cash, which cannot be sold or consumed within a year or less. They include:

  • Investments—Investments that are not expected to be sold within the year such as bonds, common stock, investments in assets not used in operation, long-term notes, pension funds or plan-extension funds. These assets are reported on the balance sheet at historical or market value.
  • Fixed assets—Items that have a lifespan longer than one year and are used in operations such as machinery and equipment and buildings. They are depreciated over time.
  • Intangible assets—Intangible assets are things like patents, copyrights, trademarks, franchises and organization costs. These assets may have infinite life and are not amortized.

Long-term Liabilities

Long-term liabilities incorporate items that you anticipate liquidating outside of the current year or cycle of operation. They are reported as the value of all remaining payments and include:

  • Notes payables—This amount usually carries interest and is the amount your company owes to a creditor.
  • Long-term debt—Current portion of a net debt that is payable over a long-term.
  • Deferred income tax liability—Taxes due in the future for income already received and reported in your financials. A future tax liability is created when a company’s tax payable is less than its tax expense.
  • Pension fund liability—Post retirement benefits of current or retired employees as contributions that are necessary for future payments.
  • Long-term capital-lease obligation—This is a written agreement under which a property owner allows a tenant to use and rent the property for a specified period of time.

Understanding your liabilities is important. They are a claim against your business assets. Investors will want to know why you’re issuing new debt so be sure to note the reason why. Debt isn’t bad, especially if you have it because you’re investing in optimizing your processes and becoming more efficient.

The combination of your long-term assets and liabilities gives creditors and other interested parties the ability to see how your business is doing beyond the current year. It can help them decide whether or not they will extend credit to your business.

Analyzing Short-term Receivables and Payables to Make Sound Business Decisions

When you’re trying to determine what money is coming in compared to money you need to pay out, you’ll need to review short-term assets against short-term liabilities.payables and receivables This helps you understand where you need to make changes in your policies and procedures to ensure your business stays cash flow positive.

Accounts Receivable s vs. Accounts Payable

Accounts receivable is money owed to your business for purchases made by customers, suppliers, and other vendors. It’s an asset. Accounts payable includes all short-term obligations owed by your business to creditors, suppliers and other vendors.

As you review your balance sheet, you may decide to change your terms or policies if your business isn’t thriving with your existing procedures. You can get an in-depth look into your accounts receivables with the Accounts Receivable Aging Report. Be sure to look closely at your terms and existing customer base and review the following:

  • Terms—What types of terms have you given customers? Do you give them a 30-day window to pay or is payment due immediately.
  • Customer behavior—Do some customers pay on time while others seem to take forever?

Just as you review your customer’s terms and behaviors, you should also take the time to review your supplier’s terms and behavior drilling down to the Accounts Payable Aging Report.

Notes Receivables vs. Payable

Many small business transactions are finalized with credit. Often times smaller business lend or receive money with promissory notes where one person promises to pay the other one back at a certain time under certain interest terms.

Notes receivables that are due within one year are current assets. These are promises to pay you for money you’ve loaned to others. Notes that cannot be collected on within one year should be considered long-term assets. Notes payables represents money owed on a short-term collection cycle of one year or less. It may include bank notes, mortgage obligations or vehicle payments.

As a small or mid-size business, notes receivables are likely to be promissory notes or employee advances. Perhaps you’ve given a customer a loan because they couldn’t make the payments on the product or service they bought from you. To avoid legal fees or the embarrassment of a collection agency calling on them, they agreed to transfer their delinquent accounts receivable balance to a promissory note. (Note: I don’t advise that you do this without the counsel of your attorney)

Notes payable could be a line of credit, accrued payroll and withholding taxes and the current 12 months of a vehicle loan that’s setup as a contra account to separate the current balance of a long-term note. The remaining balance of the loan will be found under long-term payables.

If you discover that you have a large number of outstanding notes receivable, you should consider taking measures to reduce the amount of write-offs you may see as the debt becomes uncollectable. You may even want to put a policy in place to ensure that you don’t lend out more than your business can afford to lose.

You may also want to create an account called Allowance for Doubtful Accounts. This account can accrue a bad debt balance that can be used to write off any notes payable that later become uncollectible.

Timing is important with receivables and payables. You could run into serious cash flow issues if you have a ton of money coming into your business in the next 60 days, but owe your suppliers money in the next 30 days. Timing is critical in everything, but especially in accounts and notes receivables and payables.

Balance Sheet Basics: Short-term Assets and Liabilities

The balance sheet provides an indication of the financial strength and capabilities of the business at a single point in time.balance sheet It’s helpful to review the balance sheet at the end of an accounting period to determine if you can make your bills with your projected income or if you need to take immediate steps to bolster cash reserves. You can also identify and analyze trends to determine if it’s taking longer to collect payments, whether or not you’ll want to be more aggressive on collections or determine that a debt is uncollectable.

Balance Sheet Basics

A balance sheet consists of assets, liabilities and owners’ or stockholders’ equity. Assets and liabilities are divided into short-term and long-term obligations. An asset is anything the business owns that has monetary value. Liabilities are what your business owes other people. At any given time, assets must equal liabilities plus owners’ equity.

Sometimes it’s helpful to assess short-term assets against short-term liabilities to gain a picture of the money coming in to your business and leaving it within the next year. To do this, you’ll need to understand what current assets you have, which are assets that are sold or consumed within a year or converted into cash. You’ll compare this against liabilities, which are debts payable in one year or within the operating cycle; whichever is longer.

Current Assets

The following are current assets as long as they are easily converted into cash within one calendar year:

  • Cash—Cash is considered the most liquid of all assets. Although cash is the most liquid asset on your balance sheet, you may want to ask yourself what portion of the cash is reserved to pay debts such as payroll taxes, estimated income tax and insurance. If the cash is reserved, you should consider keeping it in a separate bank account to reduce the likelihood of spending it on other business expenses.
  • Marketable securities—Short-term investments can be both equity and debt securities in a pre-existing market. As these are short-term investments, they are expected to sell within one year and are reported at their market value at the time of financial statement preparation.
  • Accounts receivable—This is the money owed to your company for credit extended to its customers for goods or services. Allowances can be made for credit extended, which may not be received due customers who are unable to meet their financial obligations. You’ll need to estimate this amount and create an account called Allowance for Doubtful Accounts. This will impact the reported sales on the income statement if there are variations in the amount recorded.
  • Notes receivable—Similar to accounts receivable, this is a more formal agreement for things such as promissory notes or short-term loans that carry interest. These notes are receivable in less than a year.
  • Inventory—This is the product that you sell or raw materials that are used to create items to be sold. Inventory is valued at the cost that it took to acquire and get the items ready to sell.
  • Prepaid expenses—These expenses include rent, insurance, taxes or other expenses that you pay in advance, but expect to receive service for in the near future. These expenses must include the original cost at the time of payment.

Current liabilities

Current liabilities are debts payable in one year or within the operating cycle; whichever is longer. They should be listed in the order of when they are due and include the following:

  • Bank indebtedness—The amount you owe the bank in the form of a bank line-of-credit or for a short-term loan, which will not take a full year to pay.
  • Accounts payable—The amount you owe for services and products that have been delivered to your company, but you haven’t yet paid for them.
  • Accrued liabilities—Include dividends payable, wages payable, customer prepayments and other things that occur before the payment is due.
  • Notes payable—Short-term loans that usually carry interest and is money owed to a creditor.
  • Unearned revenues—This is money you have from a customer because they pre-paid for a service or product, which has not yet been delivered or is not in transit.
  • Dividends payable—This occurs when you declare a dividend but haven’t yet paid it out.
  • Current portion of long-term debt—The portion of a long-term debt, which is currently maturing and any discount or premium attached to it.
  • Current portion of capital-lease obligation—The part of a capital lease, which is due within the next year and is long-term.

Balance sheets, along with income statements, are the most basic elements in providing financial reporting to potential lenders such as banks, investors and vendors.

Understanding this section of your balance sheet will give you the ability to adjust your business practices as needed. It will also provide you with the documentation required when you need it the most. In my next post, I’ll walk you through comparing assets against liabilities in order to make sound cash flow decisions.