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In addition the basic formula for accounting is Assets = Liabilities + Equity and any US balance sheet will be organized into exactly three sections with at least two subtotals for assets and for liabilities and equity. Using the basic algebra that we learned in Ms. Arithmatic s 6th grade class we can shrewdly deduce that the two subtotals must be exactly equal. So far no problem because if your balance sheet doesn t balance then you have much bigger problems then simply worrying about understanding your financial records. How Assets Are Valued Great! you re thinking let s start with the assets! Well I love an enthusiastic learner and so I will oblige. To put it very briefly assets are the total of everything your business has that has some sort of value to the business.
With balance sheet data you can evaluate important indicators concerning your business - such as your ability to meet financial obligations (current ratio days cash on hand) and how effectively you use credit to finance your operations (debt ratio debt to equity ratio). Although the balance sheet represents a given moment suspended in time it can be prepared to include information from the previous accounting period for comparative purposes. This will permit you to evaluate how your business is performing over time. Compare the current reporting period with previous ones using a percent change analysis. Do you have more assets? Have you accrued more debt? Invested in equipment and facilities? Are your pressing financial obligations (current liabilities) under control? Is the amount that payers owe you growing? Calculating financial ratios and trends can help you identify potential financial problems that may not be obvious.
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A mortgage where you pay the principal down a little each month as the property is increasing in value is good debt. That is because you add to your net worth in two ways; first you pay off the debt and the second way is that the asset that secures the mortgage (your home) increases in value while you pay off the mortgage. Both deliver increased value to your net worth. Balance sheet goals There is only one goal that you need to focus on for your balance sheet. You need to own more than you owe. The normal pattern is that the older you get the larger your net worth becomes. There are two basic dynamics that contribute to this trend. One is the miracle of compound interest. The longer that assets are allowed to compound in savings and investment products the larger the annual contribution is to your personal net worth.