The equity section of balance sheets is designed to reflect the approximate value of your business at liquidation. As the owner, assets (what you own) less liabilities (what you owe) equal your equity in the business. If you were to sell all of your assets, convert all of your inventory, collect your customer receivable balances and then use your cash and marketable securities to settle any outstanding debts, the remainder would equal that equity figure…or would it? Probably not.
There are some pieces of information you won’t find on your balance sheets:
Fair market value of assets
Generally, items on the balance sheet are reflected at cost. While assets that appreciate are not adjusted upwards, assets that decline in value below cost are adjusted downwards. Consider a 10-acre Napa Valley vineyard purchased for $20,000 in 1970. While the balance sheet might show the vineyard land value at $20,000, its current fair market value could be in excess of $100,000 per acre depending upon its location.
Intangible assets (accumulated goodwill)
What is the value of your business brand and your customer list? Your reputation? Patents? Formulas? Yelp score? All of these intangibles have value if you decide to sell your business. Think about the value of the URL for Amazon.com. The cost of buying the domain name is probably less than $100 per year, but there is a huge intangible value associated with that asset. Of course, if you are selling a business in a forced liquidation, there might be very little intangible value remaining.
Retail value of inventory on hand
Sellable inventory is generally carried at cost (unless goods have declined in value below cost; in that case, they would be valued at the lower cost or market .) What is GAP’s inventory worth? While it might cost $12 to produce a single pair of jeans, they might sell for $30 or more. The retail value of the total inventory could greatly exceed its stated value.
Value of your team
Your team’s accumulated expertise, while not recorded on any financial statement, might have value to a potential business buyer. How much expertise is at the core of Zappo’s success? Do you think that factored into their $1.2 billion selling price to Amazon?
Value of processes
The way you do things could be just as valuable as anything you sell. You won’t find that as an asset on the balance sheet. Ask the folks at McDonald’s how they consistently deliver the same hamburger everywhere you go. Those processes account for much of the cost of entry for new franchisees.
There are also accounting estimates reflected on the balance sheet. While required in order to have financial statements that conform with GAAP (Generally Accepted Accounting Principles), these estimated adjustments do not always equate to market value at liquidation.
This is an estimate of the wear and tear on fixed assets (items that last longer than a year). If you maintain your assets in an exemplary fashion, they could be worth more than your adjusted book value. On the other hand, assets that are poorly maintained could be worth less than their depreciated (or net book) value.
Purchased intangible assets like a brand name or trademark generally have a limited life. Amortization is an estimated adjustment made each year to reflect the declining value of the asset over that life. At liquidation, the remaining market value of the asset could be vastly different from its cost less accumulated amortization.
This is an accounting adjustment made to adjust inventory costs for inflation over time. Inventory recorded net of LIFO adjustments may be worth more or less than its adjusted market value when sold.
Reserve for bad debts
For financial statement purposes, customer accounts that remain uncollectible over expected periods are written off in the form of a reserve entry. At the time of liquidation, these accounts could be collectible in an amount that is higher or lower than the net adjusted book value.
Balance sheets reflect a conservative view of the value of your business assets. If you are considering a sale of your business, you might want to hire a business valuation expert to determine the fair market value of items that are reflected on and off your company’s balance sheet.
7 tips for small business accounting
You work hard at making your business a success because you love what you do—not because you love balancing the books. But accounting is a business essential that’s crucially important to your success.