Finding the Perfect Balance

Okay, I confess.

This is a misleading title intended to draw in you readers that are opposed to doing hard numbers and would rather focus on the soft sciences of psychology, marketing, etc.

Gotcha!

The perfect balance I am referring to is the Balance Sheet. This simple, usually one-page document gives a snapshot of any given business at one point in time - typically at the end of the month of a business quarter/cycle.

The beauty with the balance sheet, though, is that while tiny in size, it is a magnifying glass to everything goin on within the business itself.

Remember, the left side has to equal the right side! As a result, the assets (left side) are equal to liabilities (debt) + capital (owner's equity.) Whew. That was hard.

Take a look at the one below:

Weeklybusinesstips

June 8, 2008

Assets Liabilities

Cash $50,000 Short-term Debt $30,000

Accounts Rec $40,000 Accounts Payable $50,000

Merchandies/ Salaries $110,000

Inventory $100,000 Total Current Liabilities $190,000

Total Current

Assets $190,000 Long-term Debt $20,000

Plant/Equip $30,000

Accumulated

Depreciation (2000) Owner Equity $8000

Total Assets $218,000 Total Liability/Equity $218,000

Yes, I know it's exciting to read a balance sheet on a blog; especially one as basic as this. But the ramifications from the balance sheet are enormous, and our understanding of the business grows tremendously once we begin to dig into the balance sheet and discover that things exist there.

First, and foremost, is notice that the assets are listed from most liquid to least liquid.

Why is this the case?

As business owners, I don't need to tell you that cash is king. It's the most easily understood, and universally accepted, forms of payment. You don't need to process anything more than a receipt and the corresponding deposit slip, as the bank accepts these funds the instant they hit your account.

Account receivable, on the other hand, are from your credit paying customers. Aside from the credit card comany taking their 2-3.5% fee on each transaction from you, there is always the risk of the purchase being disputed by the customer, and the processing time takes a few more days. Thus, AR is not as liquid as cash.

Finally, inventory is listed as a current asset and considered the least liquid. This is the result of fluctuations in the business cycle and an ever-changing consumer demand for your product. Additionally, your accounting method will need to be considered for the balance sheet, as the price you paid two weeks ago to make your product may be higher or lower than when you purchased the materials. FIFO and LIFO are important elements to consider for this entry.

On the liability side, the same science is applied, using short term debts and accounts payable as the most necessary payments, followed by longer-term liabilities.

So you don't need to be a rocket scientist to realize that if you reduce your liabilities, a.k.a. - costs, expenditures, debts, etc. and your assets stay the same, your owners equity has to increase in order to balance the account! That's why costs are so important with what we do.

Imagine how great this balance sheet would improve if we simply cut our accounts payable by 20% to a total of $40,000. The owners equity would increase from $8000 to $18,000! And that doesn't even factor the possibility of increasing cash balances with increased sales or higher prices.

A few final thoughts on the balance sheet.

1. It is not wise to skip over a balance sheet. While elementary in scope, that is intentional. The balance sheet is intended to be the glossary for accompanying financial statements such as the income statement, statement of cash flows, profit and loss statement, etc.

2. The balance sheet is a snapshot of one day in time! Keep it consistent and monitor your balance sheet frequently. If not daily, at least weekly, and make it the same time each week. For instance if you have large sales on the weekend, get a Monday morning balance sheet.

3. Pay attention to variables within your business that fall into categories that can jeopardize your equity position on the balance sheet, such as accounts receivable and accounts payable. While it might increase sales in the short-run, relaxing credit standards to sell more items is seldom a wise move for the long-haul. Similarly, review your vendor accounts frequently and push for better terms as your performance paying the accounts improve. For example, you may have a perfect record paying within 30 days to all of your vendors. Go back and ask for a reduced bill if you pay in full within 15 or 20 days, such as a 2/15 net 30 (this means a 2% reduced bill if you pay it within 15 days, or just full payment if you pay after 15 but before 30 days.) Most vendors will work with you so long as your credit history with them is positive.

4. Don't dwell over the numbers! It's too easy to become bogged down and get frustrated when things don't turn your way on the balance sheet. We will later discuss how to improve cash flows, so just be cognizant of your balance sheets and find ways to make minor modifications to your business process that result in increased cash balances, reduced inventories and lower costs.

Please send your questions and/or comments to me anytime! I'd love to know that you're reading and enjoying.