Empower Your Financial Dreams
5 Ways to Empower Your Business to Success
Have you recently started a business and you wonder how...
By: Shane Bender on Feb 7, 2016 5:24:02 PM
Have you ever asked yourself where is the cash is really going in your business? You might be wondering how you are profitable but don’t ever seem to have enough cash. Have you wondered if you should expand through hiring, a new office, or a new product line? Or perhaps you are worried about the possibility of making payroll if you lost your largest customer or supplier? Have any of these questions kept you up at night? In smaller businesses that do not have a Controller, CFO, or Finance Director on staff, these questions are common for business owners. Wouldn’t it be great if we could know how much cash we would have on hand next month, in six months, or even next year?
If you have been operating a business for a while, you are probably used to looking at the Profit/Loss or Income Statement for Operating Profit or EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization). I am going to argue that this is not good enough. The most important report is your Balance Sheet. You should not only be looking at the most current month but also trends from last month and last year. You should look at key ratios such as Working Capital, AR Turnover, Inventory Turnover, Debt-to-Equity ratio, etc. Also, forecasting your Balance Sheet is important to make sure you have the cash needed for bonuses, seasonality, bad news, or taxes.
My experience working with small businesses leads me to believe that the Balance Sheet is heavily underutilized and misunderstood among small business owners. Below is a list of five reasons that the Balance Sheet is the most important report you should be looking at.
I have been involved for over 15 years creating financials that are accurate and in accordance with Generally Accepted Accounting Principles (GAAP). I remember working for a Controller early in my career who told me that if you can reconcile and explain all the balances on the Balance Sheet, then you know your financials are in good shape. He said the Income Statement can be easily manipulated, but not so much the Balance Sheet. The following is a bare bones list of essential activities business owners should do each month:
When I was in auditing at KPMG, we would systematically audit each amount on the Balance Sheet before we would deliver an unqualified (good) opinion. I have been involved in audits on both sides and have also participated in a number of due diligence engagements. In each case, the significant items on the Balance Sheet were reviewed, explained, and supporting documents were provided.
If you want to get a loan, the banker will ask for the Balance Sheet and will run key ratios such as working capital (current assets – current liabilities).
Review the Balance Sheet and keep it clean before a banker or auditor asks for it.
I can’t stress enough the importance of cash to your business. If you just focus on EBITDA, your cash could be decreasing for some of the following reasons:
In my post, Flying Blind, I explain the importance of forecasting the Balance Sheet so you can better predict your cash. A Balance Sheet forecast requires you to understand trends in your collections, prepayments, pre-billing, taxes, and accruals. Compare your forecast to the actual monthly balances to get better at forecasting and ensuring you have booked everything.
Most everyone has gone to the doctor and been weighed, had your blood pressure taken, and even had a blood test administered to check your cholesterol and sugar levels. I recently gave blood, and they did these basic tests to know if they could use my blood.
The Balance Sheet is the health monitor in your business. Therefore, each month you should review it to ensure you are improving the health. Are AR collections or inventory improving? Is the debt to equity ratio decreasing or moving to levels that you are more comfortable with?
Check out my post called Keeping Score – Why KPIs for more information on key ratios.
A healthy and improving Balance Sheet is a sign that your business is poised for growth. It is much easier to hit goals for expanding, hiring, and growing your business when you have the cash needed without the high risk or high-interest rate.
What about when the unexpected hits your business, like losing a major client? Do you have the cash to withstand a recession or lost business? I worked at a company once where we saved a certain amount of cash equal to about two to three months of operating expenses. We would regularly calculate how long we could last without a layoff if we lost our largest client.
If you are not reviewing your Balance Sheet on a regular basis, consider the risk you might be taking in your business. This is equivalent to not watching your health and not fully understanding how you are going to meet the dreams you have for your business. Reviewing your Balance Sheet ensures your financials are clean and gives bankers and auditors what they need, so why not be ready? Your Balance Sheet is the gateway to understanding your cash flow, which is important for flexibility, growth, and meeting your goals.
Photo: By George Hodan
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