Do You Understand the Story Behind Your Business Balance Sheet?
Updated: May 7, 2021
Why it matters?
As part of the equity crowdfunding podcast series, we talk about the reasons why you should know how much your business worth.
In addition to understanding the story behind the business' profit and loss and cash flow, it's crucial you know the components of your balance sheet and the story it tells you.
1. It measures the net worth of your business.
Your balance sheet consists of your assets and liabilities; your net worth is your total assets less total liabilities.
Current assets are assets that can convert into cash within 12 months; current liabilities are the amount owing and expected to be paid within 12 months;
Non-current assets are assets that can't convert into cash in the short-term; non-current liabilities are the amount owing and not expected to be paid within 12 months.
Your net worth is the owners’ interest in the business. In other words, if your business was to be wound up, this is how much you would be left with as the owner of the business.
2. It tells you if your business is solvent.
Solvency is the acid test for survival. If your business is insolvent, it’s unlikely to survive for long without immediate action to remedy this. There are two components to solvency:
A current ratio greater than 1 (current assets / current liabilities)
Positive net assets (total assets - total liabilities)
If your business is insolvent, you’ll struggle to pay bills on time, and you may be personally at risk. You must seek help immediately if your business is insolvent.
3. It allows you to track the strength of your business.
By comparing your balance sheet to previous periods, you can track whether your net worth is increasing or decreasing. The stronger your balance sheet, the easier it will be for your business to survive a downturn.
For example, if your retained earnings are diminishing over time, it’s clear that you need to take action to strengthen your balance sheet to ensure you’ll receive value upon the windup or sale of your business.
4. It highlights how your business performs against the industry benchmarks.
Key ratios not only allow you to compare your results year on year or to industry benchmarks, but they also highlight areas for improvement.
For example, calculating your debtor days may show that it takes on average 35 days for customers to pay you. If your payment terms are within seven days of the invoice, it’s clear that your debtor processes need to be reviewed and improved.
Perhaps you calculate how long it takes inventory to sell and see it’s taking twice as long to sell this year as it did last year. Or, maybe a specific product is taking a lot longer to sell than others, which may indicate you should discontinue it. Key ratios calculated using your balance sheet can tell us a multitude of things.
Every entrepreneur should be able to read their balance sheet and understand what it's telling them.
If you need help demystifying your balance sheet and identifying key areas for improvement, let's chat!