How Your Balance Sheet Informs Business Decisions
Although it would be great to be able to see into the future and know the outcome of your business decisions before you make them, business owners must have another basis for those critical decisions that can have far-reaching effects on their company and its future.
Accurate, timely data – data that comes from your financial statements – provides the most solid basis for sound decisions. Business owners I work with express that their confidence in their own decision-making gets a radical boost once they fully understand how to read, interpret, and apply the information from their financials.
Three financials are foundational to decision-making: the income statement, balance sheet, and cash flow statement. Last month I discussed how the income statement informs business decisions. This month, we’ll 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. The following are three areas in which the balance sheet can inform business decisions.
1. 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 glance at a company’s value and net worth, financial health and well-being, and whether it is succeeding or failing. Analyzing the details can help develop or modify 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 are 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 monthly rent payments, utilities, salaries, and accounts payable are payments that are due within one year. Long-term liabilities are not due within a year and may include deferred tax liability, principal and interest on bonds and 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 stocks.
2. 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 illustrates only a point in time, a balance sheet can be compared with those of previous periods to get a sense of trends over an extended period. Having this information updated regularly (typically monthly or at least quarterly) enables companies to track their level of risk and make adjustments before they are in trouble.
3. Securing Capital
Balance sheets can help a company evaluate whether it wants to raise additional capital through debt or equity. The balance sheet is then of value in securing capital and is typically requested by lenders when a business is seeking to obtain a business loan. When attempting to secure private equity, a company usually must 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.
My new Financial Fundamentals for Business Owners (FFBO) program provides the exact tools that enable owners to confidently dive into essential financials, interpret the data provided, and apply it to your decision-making process. It’s like having a fractional CFO for a fraction of the cost! Contact me if you’re interested in learning more about how this program can benefit your financial intelligence and your business.
