Your Balance Sheet – How It Informs Business Decisions
As a business owner, making critical decisions – some of which can have far-reaching effects – comes with the territory. Wouldn’t it be great to be able to see into the future and know the outcome of those decisions before you make them?
Although we haven’t quite developed that capability, there are tried and proven tools that can help eliminate a lot of the guess work – and they should be right at your fingertips. Accurate, timely data – data that comes from your financial statements – provides the most solid basis for sound decisions. Three statements are foundational to decision-making: the income statement, balance sheet, and cash flow statement.
Last month’s blog discussed how the income statement can inform decision-making. Next, let’s take a look at the balance sheet.
Sometimes referred to as the statement of financial position, the balance sheet provides a snapshot of the state of a company’s finances at a particular point in time. It itemizes what you own and what you owe. The following are three areas in which the data from your balance sheet can inform your business decisions.
- Strategy and Planning
The balance sheet is so called because it should always balance. Assets should always equal liabilities plus shareholder equity. It therefore provides a picture of the company’s value and net worth, financial health, and well-being, and whether the business is succeeding or failing. Financial analysis, especially ratio analysis, is the only way to truly understand the balance sheet. Analyzing the details can help develop or modify both strategic and organizational aspects of the company if and as needed. Balance sheet data can also be helpful in planning, budgeting, and organizing projects. Here’s an overview of data that is available.
- Asset accounts provide information about liquidity. Current assets such as cash and cash equivalents, marketable securities, and accounts receivable can be converted to cash in one year or less. Long-term investments include fixed assets or capital-intensive assets, and intangible assets – securities that cannot be liquidated in the next year.
- Liabilities include any money owed to outside parties. Current liabilities, examples of which are short-term loans, credit cards, payroll liabilities, and accounts payable are payments that are due within one year. Long-term liabilities are due beyond a year and may include deferred tax liability, principal and interest on bonds, other long-term debt, and payments to an employee pension fund.
- Shareholder Equity is the money attributable to business owners, or net assets. This element of the balance sheet will include accounts such as retained earnings and ownership accounts.
- Determining Risk
The balance sheet details all assets – everything a company owns – as well as all its debt. A business owner who has learned to read, analyze, and interpret this financial document can quickly assess whether its assets are liquid enough, if the company’s borrowing is in line with its financial goals or whether debt is too high, and whether there is enough cash on hand to meet current demands. Even though the balance sheet depicts only a point in time, it can be compared with those of previous periods to get a sense of trends over an extended time. Updating this information regularly (typically monthly or at least quarterly) enables companies to track their level of risk and adjust to avoid problems.
- Securing Capital
The balance sheet can help evaluate whether to raise additional capital through debt or equity and is valuable when securing capital since it is typically requested by lenders. When attempting to secure private equity, a company must typically also supply a balance sheet to potential private investors. In each case, the balance sheet enables the lending party or institution to assess the financial health and credit worthiness of the business, along with the company’s ability to repay short-term debts.
Regardless of company size or the industry within which it operates, every business can benefit from a timely and accurate balance sheet, both for purposes of operation and its contribution to solid decision-making. But its value is only as good as your ability to read, analyze, and understand how to apply the data it provides.
Helping business owners refine these skills is a primary focus of my work. Clients express that their confidence in their own decision-making gets a radical boost once they fully understand how to read, interpret, analyze, and apply the information from their financials. Those questions about whether and when to bring in new products or services, which projects will be too costly, or which will be profitable, are no longer quite so enigmatic.
In addition to being a primary focus with clients, this type of Financial Intelligence is an example of the topics I’ve addressed in recent seminars I’ve conducted. These important tools enable owners to confidently dive into essential financials, interpret the data provided, and apply it to the decision-making process.
The ability to decode your financials, along with your industry knowledge and strategic thinking, will empower you to make the most proactive and impactful decisions for your business. Contact me for a complimentary consultation to discuss your own financial documents, or to get information about a complimentary seminar for your company, clients, or colleagues.
