By Shane Bender
- The Balance Sheet is for my CPA, it’s not for me.
- I don’t have time to understand the Balance Sheet, but I do need cash.”
- “I make operational decisions based on the Income Statement; the Balance Sheet is irrelevant.
- The balances don’t change from month to month, so why should I care about it?
- The Balance Sheet is for bankers, investors, and auditors. I let them worry about it.
- The Balance Sheet is window dressing and only for ratios that don’t matter.
- Once business turns around, the Balance Sheet will “sort itself out”.
- A good P&L (Profit/Loss) forecast is worth much more, so that is my focus.
As a small business owner, have you had any of these thoughts regarding the Balance Sheet?
I didn’t expect to have so much activity when I posted “The Balance Sheet is the Most Important Financial Report”. I have read over 110 comments, mostly in LinkedIn groups, and decided to write a sequel to summarize the concerns, challenges, and debates. The comments came from people in many different countries, so apparently this is a world wide issue.
For starters, it is apparent that other financial professionals have experienced much of the same challenges in explaining the value of the Balance Sheet.
Based on my experience and the discussion in the LinkedIn groups, below are five excuses that business owners and executives make as to why they do not review the Balance Sheet:
1. “It is not a good report to help me run my business.”
Some people say that the main focus should be on the revenue, expense, profits, and key performance indicators (KPI’s).
I get this concern, and wrote about KPIs in my article “Keeping Score – Why KPIs?. Although, you will find that many important business KPIs are also Balance Sheet metrics, such as working capital (current assets – current liabilities), and Days’ Sales Outstanding (Accounts Receivable/Net Credit Sales (Billings) x 365 and many more. Check http://www.myaccountingcourse.com/financial-ratios for many more ratios.
The Income Statement and the forecast of your revenue, expenses, and profit are important. Although, if debit balances and bad accounting is being hidden in your Balance Sheet, then what good is the Income Statement? One person commented that he worked with a client who had many debit Accounts Payable balances which affected the margin on their contracts. By having incorrect contract margins, it was easy to make bad decisions moving forward and not understand the business environment.
2. “It is for CPAs, Auditors, Investors, and statutory requirements.”
Some small businesses only worry about the Balance Sheet once a year for a Review or Audit. Maybe the financials are cleaned up for their tax return, which in the US can be extended and reported on October 15 (9.5 months after the end of the previous year). In this case, I can see how the Balance Sheet is very irrelevant. Since business moves along at a fast pace, nobody cares about reports from nearly a year ago.
Why do the auditors and bankers care about the Balance Sheet? It truly helps them have a snapshot of a business’s assets, liabilities, and equity. For the banker, if the Balance Sheet looks good, they feel comfortable loaning more. If you have bank covenants, most likely they have Balance Sheet ratios that you need to comply with. If this is the case, then a good Balance Sheet forecast and calculation of these ratios will be important. For the auditor, if the Balance Sheet is clean, they feel better about the Income Statement. I suggest that you review and adjust the Balance Sheet to detailed reconciliations on a monthly basis to avoid significant year-end adjustments.
I get it. You still don’t care about the bankers and auditors. You are trying to run your business. My point is that you do need to run your business with the best information possible. So don’t wait. Review your Balance Sheet so you aren’t being misled by the financials.
3. “I don’t have time to understand it.”
If you are a business owner and your business is growing fast, then you are undoubtedly too busy to go through accounting training on the Balance Sheet. This makes perfect sense. I would suggest hiring a part-time CFO or Controller to help you review the report monthly and understand its value. Over time, you will get better at it. I read a comment from a business owner who said that he knew he had to learn the skill of understanding his Balance Sheet. Once he learned this skill, it has helped him be a much better business owner.
4. “When Revenue and Profits are good, everything else will work out.”
The Balance Sheet can be a place to hide numbers until business gets better. There is a certain mindset that if we work hard at increasing revenue and profits, then all problems will be solved. I have heard it said many times that revenue and profit cures all evils.
The problem with this kind of thinking is that it is not taking into account downside risk. What if something is going on in your business and it is keeping you from being competitive? What if there is fraud or misappropriation of assets? What if competition or industry changes are affecting your business and you aren’t addressing this fast enough due to an incorrect Income Statement?
5. “It is just plain boring.”
In my experience, since the Balance Sheet does not change much, then it appears boring and doesn’t excite small business owners.
I would argue that a Balance Sheet that does not fluctuate too much is a good thing. It is important to review the current month’s balances with last month and last year. Trend out the balances for the next 12 months. Maybe this will give you a better feel for your potential cash availability for projects and large expenditures to grow your business.
The more you understand the value of the Balance Sheet, the less boring it will be.
In summary, the Balance Sheet is a good operational report if it is current. It must be important if bankers, investors, and auditors rely so heavily on it. There are many ways to get trained on the Balance Sheet, and one way is to hire a fractional CFO. It will be worth it. Don’t just assume all will work out well. I agree optimism is good, but not blind optimism. Finally, the Balance Sheet can be very interesting when you look at trends over time. The more you review it and learn it, the more exciting it will become. Hasn’t that happened to you with other subjects you have learned more about over time? In conjunction with the Income Statement and Statement of Cash Flow, the Balance Sheet is the most important financial report.
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