The balance sheet is one of the many financial statements that is useful for e-commerce business owners to understand. In this article, we’ll go through what’s on the balance sheet, how to analyse it and the ratios you’ll want to track. Please not, this isn’t intended to be financial advice. We recommend reaching out to an accounting professional for further guidance.
Your balance sheet will show your business’s financial position at a single point in time, typically at the end of a certain period, such as a month, quarter or year. It gives you an understanding of what the business owns and what it owes. These factors help to showcase overall health and viability, both in the short-term and long-term.
What’s on the balance sheet financial statement?
You will be able to see all of the business’s assets on the left, and liabilities and owner’s equity on the right. The two columns will have an equal amount, or balance, hence the name, balance sheet. If the two columns don’t balance, there is an error somewhere along the way in your bookkeeping.
Assets and liabilities can be considered current or noncurrent. Current assets are those that can be turned into cash within a year such as inventory. Non-current assets are those with values that won’t be recognised within a year such as equipment. Similarly, current liabilities are those due within a year and noncurrent liabilities are those due in over a year’s time.
Assets are the items owned by the company. Examples include:
- Bank accounts
- Accounts receivable
- Prepaid expenses
Liabilities are owed by the company to others. Examples include:
- Bank loans
- Accounts payable
- Wages owed
- Credit cards
Owner’s equity is assets minus liabilities and is the amount that can be claimed by the owners of the business. It can include:
- Money invested by the owner
- Money taken out by the owner
- Profits from business
Why should you keep track of your balance sheets?
There are a few reasons why e-commerce businesses should be staying on top of their balance sheets. If you keep track of your balance sheets on a regular basis, you can better compare your current results to your previous results and even use this to predict future cash flow. Plus, the insights can help you set realistic goals for the next period.
On top of being able to compare your own results from period to period, you can compare yourself to competitors and industry benchmarks as well. For example, based on a recent e-commerce merchants report, the average gross margin is about 45%. These benchmarks can help you understand whether you’re in a safe or risky position in the market.
In the next couple of sections, we’ll be going through some key trends or key performance indicators (KPIs) that can suggest your company is on the right track. Especially as your business grows, it becomes more and more useful to work directly with an accounting professional. However, if you’re just starting out, a basic understanding can go a long way.
How to analyse your e-commerce business’s balance sheet
Rather than giving insights into day-to-day operations the way an income statement does, your balance sheet gives you an understanding of the overall health of your business. This is useful to track the growth of your business, as explained above, or to showcase your business’s value, such as when applying for a loan or selling your business.
Before you start delving into the numbers, it’s important to check that everything has been recorded accurately. This involves getting the right e-commerce accounting integrations and e-commerce inventory integrations. A few trends or KPIs that highlight that your business has been performing well:
- Growing cash balances and assets
- Sufficient cash on hand to pay expenses
- Decreasing or manageable debt levels
- Less assets producing more revenue
- Inventory is being turned over and not building up
- Prepaid and in-transit inventory
- Enough investment and reinvestment into the business
- Net worth is growing
Ratios from your balance sheet relevant to e-commerce
When we start talking about ratios, it can start to get a little bit daunting or overwhelming. To keep things as simple as possible, we’ll go through three of the most important ratios relevant to e-commerce businesses and give easy-to-understand examples. Keeping track of these ratios will help you understand your solvency and asset management.
The first ratio we’ll look at is the current ratio. This ratio helps you understand your e-commerce business’s solvency or its ability to pay off debts and financial obligations. The ratio is calculated by dividing your total current assets by your total current liabilities (current assets/current liabilities). Make sure you’re not including noncurrent amounts.
For example, if your total current assets were worth $100,000 and your total current liabilities added up to $25,000, your calculations would be 10,000 / 2,500 = 4. This means for every $1 that you owe, you have $4 dollars in current assets that you own. If this ratio were to dip below 1, it would mean you don’t have enough current assets to pay off your current liabilities.
Quick ratio/working capital
Next is the quick ratio or working capital which is similar to the current ratio in the sense that it gives you a perspective on your solvency. For this ratio, you only take your most liquid current assets and divide that by your current liabilities. For example, you might be reasonably certain that you can liquidate your inventory if needed, however, you can’t liquidate prepaid expenses.
If we consider the same scenario, however, this time, our total most liquid current assets only add up to $30,000. If we divide that by $25,000, your calculations would be 30,000 / 25,000 = $1.2. Obviously, this is just an example, but if this were the case, your quick ratio would show that you’re not as solvent as your current ratio suggests. It’s useful to track both ratios.
Last but definitely not least is your inventory turnover. We’ve spoken about this in a previous article on e-commerce KPIs you need to measure but will go through it again here.Your inventory turnover measures the rate at which you’re selling through inventory within a period of time. Your goal is to have enough stock-on-hand while not having too much excess.
Let’s say we’re comparing balance sheets from quarter-to-quarter. The basic formula for inventory turnover is COGS divided by average inventory. To get your average inventory, you take the value of your beginning inventory, add your ending inventory and half the answer. For instance, (25,000 + 17,500) / 2 = 21,250.
Next, you take your COGS and divide it by your average inventory. For example, if your COGS was $35,000, your inventory turnover would be 35,000 / 21,250 = 1.65. Instead of COGS, some accounting professionals will use sales revenue instead. However, COGS can be more accurate as it doesn’t include your markup. In saying this, it can be worthwhile to compare both values.
Your inventory turnover highlights how many times you’ve gone through your inventory in that period of time. In this scenario, you’ve turned over your inventory 1.65 times in one quarter. It’s hard to say at face value whether this is good or bad. It’s more useful to compare changes over time. Generally, you want the number to be as high as possible while making sure you don’t have lengthy periods where items are out of stock.
Key takeaways on balance sheets for e-commerce businesses
The balance sheet is often left behind by e-commerce business owners in place of the income statement or cash flow statement. However, it plays a major role in making sure your financial health is up to par and can help you identify critical issues. Having a foundational knowledge of your e-commerce balance sheet can make or break your success!