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Understanding a Balance Sheet
Here are 5 Top Tips to help you
Business finance is like aircraft instrumentation. For the business manager or owner to ignore or not understand their financial is similar for an air plane pilot ignoring or not understanding aircraft instrumentation.
It’s not a question of ‘if’ but ‘when’ the business will potentially crash.
The oil giant BP may not ‘crash’ but it has felt the impact of the oil price slide on its balance sheet. The City expects the company to report full-year profit of £6.5bn – down more than a quarter on the previous year – as the falling oil price begins to bite. It is also expected to update on job and spending cuts.
Understanding a balance sheet is critical for EVERY business, whether it’s BP or the small corner shop.
So with this in mind, here are 5 Top Tips which outline some of the items found on your balance sheet:-
- Cash and Accounts Receivable
Most businesses that go buys are profitable – they just run out of cash.
Cash is the blood running through your body – don’t run out!
Collect from customers slowly enough to keep them happy but fast enough to keep you solvent.
Three things not to get confused – what goes in (called additions to inventory), what goes out (called cost of goods sold) and what level to maintain (ending inventory position).
Also, you can add to inventory in only three ways: make it, buy it or burden it with manufacturing overhead. To buy and when to buy is always the question.
- Other current assets
A favourite accounting concept if ‘working capital’ which is current assets minus current liabilities.
The only cash in working capital is what is in the cash account at the top of the balance sheet. Don’t be fooled – you can’t spend working capital!
- Fixed assets
Be sure that you have enough operating cash flow or can get enough cash from debt or selling stock to cover investments in fixed assets and still cover your operating expenses.
See or write-off non-productive fixed assets – the ROA (Return on Assets) for a given net profit will go up if assets go down. ROA=Profit/Asset.
- Accounts Payable
Watch payables turnover – you pay too late and make your vendors unhappy. Pay too soon and run out of cash.
Forget conventional wisdom that suggests stringing out your pay day period. If you have plenty of cash, pay vendors promptly. You’ll keep good relationships and improve ROA by reducing total assets.
Want to read the rest of the Top Tips for Understanding a Balance Sheet?
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