Why Your Balance Sheet Deserves Attention
I get it. You might not want to talk about your Balance Sheet. It's not incredibly exciting. And it's not what people typically want to talk to you about. They usually just want to talk about your Revenue. Maybe your margin. If they're really sophisticated, maybe they want to dissect your full P&L (not PNL). And that's great. And that makes sense. It's where you spend a significant amount of time. Reviewing performance. Identifying obstacles. And celebrating successes. But in focusing on the P&L (not PNL) and detailed Sales Metrics, are you neglecting the Balance Sheet?
The Importance of Reviewing Your Balance Sheet
Reviewing your organization's performance without digging into the Balance Sheet is like a college admissions officer only looking at an applicant's academic performance for the last nine weeks. But that's not enough - we need more. We need the full high school transcript. The cumulative grade point average. The life-to-date scorecard. And that, my friends, is the Balance Sheet.
What is the Balance Sheet?
At its most basic level, the Balance Sheet is a financial statement that presents an organization's financial position at a specific point in time. It shows your organization's Assets (think Cash, Accounts Receivable, Inventory). It shows your organization's Liabilities (think Debts, like Loans, Accounts Payable, and Pending Payroll). And it shows your organization's Equity (think Shares and Retained Earnings).
And it's called the "Balance Sheet" because... drumroll please... it B-A-L-A-N-C-E-S!!
Assets = Liabilities + Stockholders' Equity
Understanding the Balance Sheet's Role in Financial Health
The Balance Sheet is crucial for determining the organization's overall health and wellness. From just one Balance Sheet review, you can see if your Assets are sufficient to cover your financial obligations. You can assess if you're highly levered (high multiple of debt compared to your equity), evaluate your Cash flow by calculating your Conversion Cycle, and gain many other incredible insights.
Why Look at a Trending Balance Sheet?
If you really want to dig in, we should look at a trending Balance Sheet. A series of your organization's Balance Sheets at different points in time, maybe year over year for a three to five-year period, or month over month for a twelve-month period. This allows us to "read the green," showing how your organization's financial position has shifted over time. Performing a trending fluctuation analysis or an overall metric trending review can uncover issues that are not easily detected by a mere glance at your Balance Sheet.
A Real-Life Example
Still not convinced? Here's a true story.
Let's say your Sales and Expenses look great. Sales are up, Expenses are down, and your P&L and Net Margin are strong. But Cash has been feeling tight lately, and you've had to borrow more than usual against your Line of Credit. You've been really busy, so you've not yet noticed that the line is almost maxed out. And it's about to impact Operations.
Digging Into the Details
Inventory: We see that we've been buying way more inventory than usual. In fact, your inventory balance is three times higher than average. It's almost like we're stockpiling.
Accounts Receivable: Our balances with two of our largest customers have grown exponentially. In fact, it doesn't look like we've received a payment from either customer in about four months.
Resolving the Issues
Through conversations with Supply Chain, we learn that a new Supervisor bought more inventory than usual to get a better volume discount, not considering cash management or liquidity. This practice went undetected due to a lack of appropriate internal controls.
In Accounts Receivable, we find that two large customers have been sending checks to the wrong lockbox due to a recent bank transition, which was not properly communicated.
Fortunately, these issues were easily resolved, and to prevent this from persisting, we instituted appropriate internal controls within Supply Chain, monthly AR reviews with Revenue Cycle, and a robust monthly Balance Sheet review.
Establishing a 13-Week Rolling Cash Forecast
Lastly, we established a 13-Week Rolling Cash Forecast. Because, every business needs one of those. And, well, wait. You've got one of those, right?
