The Value Of Your Company Is Not On The Balance Sheet
The Other Side of Your Balance Sheet – Liabilities and Owner’s Equity
This week we are continuing our overview of the Balance Sheet. Your balance sheet summarizes what the business owns and what it owes at a particular point in time. The difference between the Assets and the Liabilities is The Shareholders’ Equity.
The balance sheet “balances” because the values in the asset side of the balance sheet equal the value on the right-hand side.
Assets = Liabilities + Shareholders’ equity
Liabilities, like the assets, are organized into short-term and long-term liabilities. Current liabilities are those that are short-term and payable within the year. Accounts payable are an example of a current liability.
Debts that aren’t due in within twelve months are classified as long-term liabilities. A loan that you will pay off in three or four years, like a truck loan, will be classified as a long-term asset. Long-term debts may come from a variety of sources.
Shareholders’ equity might also be called Owners’ Equity. This is the net residual that the owner owns. Another name for that category is Owners’ Equity. In other words, if the owners sold all the assets and paid off all the liabilities, whatever would be left over would belong to the shareholders.
All of that seems straightforward enough but here is where things begin to get interesting. The numbers on the balance sheet are supposed to be listed at historical cost. (According to GAAP, Generally Accepted Accounting Principles). You can’t look at the Shareholders’ Equity on the Balance Sheet to determine what the company is worth!
Market Value compared to Book Value
THE VALUE OF YOUR COMPANY IS NOT FOUND ON THE BALANCE SHEET. Since assets are listed at cost, the value could be much more than what is shown on the balance sheet. For example, if you bought the land where your business is operating 30 years ago, it will show on your balance sheet for the cost you paid then. To determine the current value, you need to get a current appraisal for the real estate. Similarly, there are some assets that don’t appear on the balance sheet at all. Your brand and employees don’t appear on the balance sheet and in a well-run company, they may be worth a significant amount in the market. Going back to your Balance Sheet equation, you will note that these improvements in the asset values would result in an increase in the Shareholder’s equity.
This is why those of you with more than one owner and Buy-Sell Agreements in place will find a valuation methodology outlined in your document. It states how the market value of the company will be calculated as time goes on. The parties to the buy-sell arrangement expect that the value of the entity will increase over time and in the event an event occurs to trigger the buy-sell, they will want to have a previously agreed upon a formula to calculate value at that time. More on buy-sell arrangements later.
Would you like to discuss your financial results and how your company might maximize its value? Have you been wondering what steps a smart owner can take now to prepare for an exit from the company while achieving his/her goals? We will be happy to have a confidential complimentary conversation with you.
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