One question that frequently arises among entrepreneurs when seeking capital for their business is “how will investors interpret the financial statements that I provide in my business plan?” It’s a good question and something every entrepreneur should understand when dealing with investors, whether they be angels, venture capital, hedge funds private investors or any other source of funds. Let’s talk briefly about the balance sheet.

The balance sheet is a snapshot, if you will, of your company’s financial position at a given point in time. It is expressed in terms of assets such as cash, receivables and physical items owned by the company, liabilities, or money owed by the company against those assets and stockholder’s equity which represents the initial investment by owners and any past profits that have been retained in the business.

The balance sheet is aptly named because the assets of must equal the sum total of liabilities and stockholders’ equity. Said another way, a company’s assets less its liabilities is the stockholder’s equity in the company. Obviously, this is a very important indicator a company’s overall value to an investor.

An investor that is considering funding your company will look to the balance sheet to get an indication of your company’s financial strength. The investor will look at assets to see what your company owns. Large amounts of cash and marketable securities, sometimes called liquid assets or current assets, are attractive as they give a positive indication of the ability to meet near term obligations. Other assets such as intellectual property and brand names could also be attractive because the potential to monetize those assets is sometimes substantially more than the value reflected on the balance sheet. Large amounts of goodwill, or the amount you may have paid for your company above its book value, relative to total assets could be a red flag due to its intangibility and illiquid nature.

A view of your company’s liabilities gives an investor a picture of leverage, the amount of debt your company is carrying relative to your company’s net worth. In other words, if the company were forced to liquidate could it pay all of its bills and have something left over for them? A close examination of your company’s liabilities will also give the investor an indication of how much cash will be required to meet near term obligations and, by comparing to assets, your company’s ability to meet those obligations.

In addition to telling a potential investor how much equity the owners have in your company the stockholder’s equity section of your balance sheet will also give an investor insight as to how much money has already been injected into your company, the number of outstanding shares in your company’s stock and your company’s use of earnings. The line entitled additional paid in capital and shares outstanding lines plainly tell an investor how much capital has been put into your company and how much stock you had to issue in return for this capital. The retained earnings line will tell an investor how much of past earnings you have retained in the company. A historical analysis of the retained earnings account will also give an investor hints regarding dividends.

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