What’s So Important About A Balance Sheet?
April 04, 2016
Most of the time we think about an income statement being important but never give much thought to the balance sheet. It is an important financial statement and all small businesses should prepare this statement at the same time when preparing an income statement.
A balance sheet lists all of the assets and liabilities of a business. If on the accrual basis of accounting (as opposed to the cash basis of accounting), a balance sheet will show the total amount of debt that is outstanding...an important figure for forecasting cash flow in knowing when debt servicing (principal and interest) will be due.
When comparative (historical) balance sheets are prepared, an owner can see what assets and/or liabilities are increasing or decreasing. This is valuable when spotting trends either positive or negative. Examples might be reviewing the trend of receivables, payables, inventory, employee loans, etc.
Reviewing a Balance Sheet
Balance sheets can be reviewed in a number of ways: (1) year-to-year or period-to-period comparisons and (2) dollar and percentage comparisons. Every account on a balance sheet should be reviewed. The reader should look for anomalies – predictors of something that needs attention. These could be positive or negative abnormalities.
Some indicators of a negative or abnormal trend might indicate:
(1) Receivables getting old
(2) Liabilities being paid late
(3) Inventory getting stale and obsolete
(4) Payroll taxes not being paid
When negative trends are spotted, immediate action should be taken rather than postponing an important action decision that could have an impact on the bottom line profit.
Contingent liabilities are a type of liability that small business owners should be aware of that could affect future cash flow. They are liabilities that are likely but not certain to happen. Examples might be:
(1) Possible outstanding litigation
(2) Warranty work that would require cash outlays
(3) Coupons in which service needs to be completed or products delivered
(4) Retirement plans not accrued or funded
It is not possible to accurately predict future cash flow needs if contingent liabilities are not taken into consideration. Small businesses must have cash available to handle all types of situations if they materialize. A solution for many small businesses is to actually establish separate bank accounts to handle such contingencies and simply move the cash back to a normal operating account when the contingent liability no longer exists.
Debt is always a heavy burden for small businesses. There are some ways depending on the business and its financial condition to reduce principal and interest debt payments.
Some typical strategies are:
(1) Debt consolidation
(2) Restructure/refinance long-term debt to reduce payments/interest rate
(3) Reduce length of maturity reduces interest paid
(4) Refinance home and use equity to pay down business debt
Balance Sheet on Cash and Profits
Although balance sheet items do not have a direct effect on sales and profits, they can increase cash and/or profits depending on action taken such as:
(1) Work on past due receivables by aging receivables by date, reviewing current credit policy (may be too lenient or too strict), or deciding to take cash and credit cards only.
(2) Implement tight cash controls to reduce cash shortages.
(3) Carry the right inventory and sufficient inventory meaning carry what sells and in the right amount (not too much or too little).
(4) Have a vehicle reimbursement policy with either accountable or non-accountable plans.
(5) Take advantage of vendor discounts, if allowed.
(6) Restructure and re-organize credit card debt by reviewing outstanding balances and interest rates charged.
(7) Avoid late charges on payables.
Posted by Richard Weinberger, PhD, CPA
Chief Executive Officer
Association of Accredited Small Business Consultants