There are several financial statements that the business world needs to consider, but us dentists really just need to focus on the Income Statement (P&L) and the Balance Sheet. The former, which I discussed last week, is super-duper important and should be examined annually, semi-annually, and possibly even quarterly. The Balance Sheet, which we’ll discuss now, is really only regarded during major transitional events.
First, what is a Balance Sheet? It’s a snapshot of a company’s financial health. While a P&L shows income over a period of time (a year, six months, etc), the Balance Sheet is listed as of a certain date. To use scientific jargon, a P&L is like a longitudinal study and a Balance Sheet is like a cross-sectional study. And while a P&L shows Income as Revenue – Expenses, the Balance Sheet formula is:
Assets – Liabilities = Owner’s Equity
(Note, the classic formula is listed as Assets = Liabilities + Owner’s Equity)
Assets are the stuff owned by the business, including cash in the bank, accounts receivable (what patients and insurance companies still owe you), your equipment, and so on. They are typically listed in descending order of liquidity, meaning cash is at the top and the stuff that is hardest to convert into cash at the bottom.
Liabilities are the all of the things the business has to pay, including, accounts payable (e.g. outstanding bills) and debts (e.g. practice loans). These are typically listed in descending order of when they are expected to be paid, from short term at the top down to long term at the bottom.
Owner’s Equity is, according to the formula, everything that’s left over when you subtract liabilities from assets. It represents what the owner’s own after all their debts have been paid. Depending on how your business is organized (e.g. LLP vs S-Corp), the equity can be listed as stock and retained earnings (what the business keeps in the bank).
There are dozens of ways to organize a Balance Sheet. The important thing is to understand what the accountant is presenting to you and how the elements are fitting together. So rather than look at a formal balance sheet, let’s look at a common, graphic way to illustrate the concepts.
Let’s say our business, Amazing Dentistry LLP, has a simplified Balance Sheet as of October 31st that looks like this:
We don’t have any major outstanding liabilities, so when you add the value of our equipment plus our cash in the bank, you get $600,000 of pure equity. Note that the left side (assets) must equal the right side (equity plus liabilities) to be in balance, hence the term, Balance Sheet.
Now you and I are getting a little frisky and we want to buy some fancy new equipment, like CAD/CAM or a cone beam. We take out a loan for $200,000 to pay for it. Here’s what the simplified Balance Sheet would look like as of November 15th when the deal is done:
On the right side we list the loan (a liability), adding $200,000 to the equation. That has to balance on the other side, so we increase the value of the equipment to $600,00 to account for the shiny, new piece of tech that we bought. Our cash on hand of $200,000 hasn’t changed and neither has our equity. You and I still have $600,000 of equity in the practice because we don’t actually “own” that new equipment; the bank that gave us the loan does. That’s why the value is listed as a liability rather than equity.
Balance Sheets are really only viewed during transitional events, such as taking out a loan, buying/selling the practice, and similar types of events. It’s important to note that the Balance Sheet doesn’t tell us the value of the practice for buying or selling it; value is a more complex analysis and there is great variance between experts on how that should be calculated.
For more information on Balance Sheets, check out:
Investopedia’s article and video
A CE article about financial statements in dentistry