Do you view your balance sheet as simply a requirement from your accountant?
Is a balance sheet something where you “park” numbers or assets?
Do you wonder why small businesses even bother with balance sheets?
You are not alone.
Instead of adding even more complicated financese to the mix, let’s consider a football team. Their performance, and their potential to succeed, is a perfect analogy for small business financials. While profit is the way businesses keep score, a smart team knows that ensuring they have all the proper equipment, players, strong defense and an aggressive offense is the way to win.
Your balance sheet tells you the condition of your team and the resources you have available to finish the game and claim the Super Bowl brass ring.
Small Business Balance Sheet: Defined
Small business owners often express their frustration with the complexities of financial statements. “Yes but what does it really mean?” is a question I hear all the time. What they are really asking is, “What does this mean to my business success? Will I profit by it? Will it help me succeed?”
Understanding your balance sheet will absolutely help your small business grow its bottom line and reach your goals. Consider the position of a kicker in football. There are often jokes about them, and they are generally the lowest paid starter (first string) position on the team.
I remember watching a game where the kicker was injured, and there was no backup. Suddenly the team was faced with losing the extra point on touchdowns, as well as the reliable option of going for a field goal. What a game changer. A review of the team roster (their assets) would have shown this weakness, a weakness that cost them the game.
A balance sheet provides a summary of all your assets (again think players, equipment, etc.), all your liabilities (injuries), and your shareholders’ equity (team owners). For every balance sheet the following equation must hold true:
Assets = Liabilities + Shareholders’ Equity (or Surplus for a Nonprofit)
Small Business Balance Sheet: Reading at Glance
A balance sheet is a snapshot. It tells you about all the assets of your business and all the claims against your business at a specific point in time. This is important to keep in mind. Imagine a football team looking at their injured list from 4 weeks ago when deciding on the starting players for that day’s game. Doesn’t really make sense, does it?
There are three main categories in a balance sheet;
iii. Shareholders’ Equity (also referred to as for nonprofits)
All assets were not created equal for the small business owner. Since cash and cash flow are always a consideration for small businesses the liquidity of assets is crucial. Liquidity is another way of saying how quickly can you convert an asset into cash without losing value. Highly liquid assets are cash (of course!), bank CD’s, and (hopefully) accounts receivable.
Other categories in assets include; inventory, pre-paid expenses, investments, fixed assets, and intangible assets. While these don’t require monthly review, it is important to do an assessment at least once a year.
Key Business Points
- Know at a glance what is available quickly for your cash needs. It’s possible to be growing like crazy and cash poor, in fact some businesses have grown themselves into failure.
- Keep a close eye on your accounts receivable. If this is growing, or makes up a large percentage of your assets, you need to step up collection activities.
This section summarizes the monies your company owes to others. The main split here is between current liabilities (due in less than 12 months) and long-term liabilities (over 12 months). The potential liability from warranties is recorded here, as well as taxes incurred but not yet paid.
Key Business Points
- Just as important as knowing cash on hand, a small business needs to keep their finger on the pulse of what they must pay out in the near future. Don’t forget, current liabilities only reflect expenses already incurred.
- Do you know how the mob was brought down? Not for murder – for TAXES. That’s right, it was the IRS that brought the mob to its knees. Keep a sharp eye on taxes due, and the deadlines set by Uncle Sam.
If you had to liquidate your business today, and could get book value for all your assets, then shareholders’ equity represents the money you would receive for the business after all debts were paid. If you have partners in the business, this value would be split between you.
Key Business Points
- Shareholders’ Equity that is negative, or close to zero, is a huge red flag. It means that you don’t even have sufficient assets to cover your liabilities. Investigate and address immediately.
What is the financial health of your business? Does your balance sheet report lots of unexpected injuries (liabilities)? Are your cash reserves sufficient for the upcoming months? What is the status of your accounts receivables and shareholders’ equity? Just 10 minutes a month will give you crucial insights to your small business, and assist you in winning the profit game.
P.S. If anyone knows why most NFL teams don’t have a backup kicker and the starting kicker is one of the lowest paid on the team please share.